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Department of the Treasury
Internal Revenue Service
Instructions for

Schedule M-3 (Form 1120-S)

(Rev. December 2019)
Net Income (Loss) Reconciliation for S Corporations With Total Assets of
$10 Million or More

Section references are to the Internal Revenue Department of the Treasury separate U.S. income tax returns. The
Code unless otherwise noted. Internal Revenue Service Center consolidated accrual basis financial
Ogden, UT 84201-0013 statements for C and D report total
Future Developments assets at the end of the tax year of $12
For the latest information about million after intercompany eliminations.
Who Must File
developments related to Schedule M-3 C reports separate company total
(Form 1120-S) and its instructions, such Any corporation required to file Form
year-end assets on its Schedule L of $7
as legislation enacted after they were 1120-S, U.S. Income Tax Return for an
million. D reports separate company
published, go to S Corporation, that reports on
total year-end assets on its Schedule L
IRS.gov/Form1120S. Schedule L of Form 1120-S total assets
of $6 million. Neither C nor D is required
at the end of the corporation's tax year
to file Schedule M-3 for the current tax
that equal or exceed $10 million must
year. C or D may voluntarily file
General Instructions file Schedule M-3 (Form 1120-S). A
Schedule M-3 for the current tax year. If
Applicable schedule and instruc- corporation or group of corporations that
C or D doesn't file Schedule M-3, it must
tions. Due to the generally unchanging completes Parts II and III of
file Schedule M-1. If C or D files
nature of Schedule M-3 (Form 1120-S), Schedule M-3, isn't required to
Schedule M-3, it must either: (i)
these instructions will no longer be complete Form 1120-S, Schedule M-1,
complete Schedule M-3 entirely; or (ii)
updated annually, unless necessary. Reconciliation of Income (Loss) per
complete Schedule M-3 through Part I
Books With Income (Loss) per Return.
For previous tax years, see the and complete Schedule M-1 instead of
applicable Schedule M-3 (Form 1120-S) A U.S. corporation filing Form 1120-S completing Parts II and III of
and instructions. For example, use the that isn't required to file Schedule M-3 Schedule M-3.
2018 Schedule M-3 (Form 1120-S) with may voluntarily file Schedule M-3
the 2018 Instructions for Schedule M-3 instead of Schedule M-1. Completing Schedule M-3
(Form 1120-S) for tax years ending (Form 1120-S)
December 31, 2018, through December Any corporation filing Schedule M-3
30, 2019. must check the box on Form 1120-S, A corporation that is required to file
item C, indicating that Schedule M-3 is Schedule M-3 (Form 1120-S) and has at
Purpose of Schedule attached (whether required or least $50 million total assets at the end
Schedule M-3, Part I, asks certain voluntary). of the tax year must complete
Schedule M-3 (Form 1120-S) entirely.
questions about the corporation's Example 1.
financial statements and reconciles 1. U.S. corporation A owns U.S. A corporation that (a) is required to
financial statement worldwide net subsidiary B and foreign subsidiary F. file Schedule M-3 (Form 1120-S) and
income (loss) for the corporation (or For its current tax year, A prepares has less than $50 million total assets at
consolidated financial statement group, consolidated financial statements with B the end of the tax year or (b) isn't
if applicable), as reported on Part I, and F that report total assets of $12 required to file Schedule M-3 (Form
line 4a, to income (loss) per the income million. A files a U.S. income tax return 1120-S) and voluntarily files
statement of the corporation for U.S. with B (a corporation that has made a Schedule M-3 (Form 1120-S) must
income tax purposes, as reported on qualified subchapter S subsidiary either (i) complete Schedule M-3 (Form
Part I, line 11. election) and reports total assets on 1065) entirely or (ii) complete
Schedule M-3, Parts II and III, Schedule L of $8 million. A's U.S. tax Schedule M-3 (Form 1120-S) through
reconcile financial statement net income group isn't required to file Schedule M-3 Part I and complete Form 1120-S,
(loss) for the U.S. tax return (per for the current tax year. A may Schedule M-1 instead of completing
Schedule M-3, Part I, line 11) to total voluntarily file Schedule M-3 for the Parts II and III of Schedule M-3 (Form
income (loss) on Form 1120-S, current tax year. If A doesn't file 1120-S). If the corporation chooses to
Schedule K, line 18. Schedule M-3, it must file complete Form 1120-S, Schedule M-1
Schedule M-1. If A files Schedule M-3, it instead of completing Parts II and III of
must either: (i) complete Schedule M-3 Schedule M-3 (Form 1120-S), line 1 of
Where To File Form 1120-S, Schedule M-1 must equal
entirely; or (ii) complete Schedule M-3
If the corporation is required to file (or through Part I and complete line 11 of Part I of Schedule M-3 (Form
voluntarily files) Schedule M-3 (Form Schedule M-1 instead of completing 1120-S).
1120-S), the corporation must file Form Parts II and III of Schedule M-3. For any part of Schedule M-3 (Form
1120-S and all attachments, schedules,
including Schedule M-3 (Form 1120-S), 2. U.S. corporation C owns U.S. 1120-S) that is completed, all columns
and statements at the following subsidiary D. For its current tax year, C must be completed, all applicable
address. prepares consolidated financial questions must be answered, all
statements with D, but C and D file numerical data asked for must be

Nov 21, 2019 Cat. No. 48245B

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provided, any statement required to        Total assets shown on Schedule L,          Entity Considerations for 
support a line item must be attached       line 15, column (d), must equal the total 
and provide the information required for   assets of the corporation as of the last   Schedule M-3
that line item.                            day of the tax year, and must be the       For purposes of Schedule M-3, 
                                           same total assets reported by the          references to the classification of an 
Any corporation filing Schedule M-3        corporation in the non-tax-basis           entity (for example, as a corporation, a 
must check the box on Form 1120-S,         financial statements, if any, used for     partnership, or a trust) are references to 
item C, indicating that Schedule M-3 is    Schedule M-3. If the corporation doesn't   the treatment of the entity for U.S. 
attached (whether required or              prepare non-tax-basis financial            income tax purposes. An entity that 
voluntary).                                statements, Schedule L must be based       generally is disregarded as separate 
                                           on the corporation's books and records.    from its owner for U.S. income tax 
Other Issues Affecting                     The Schedule L balance sheet can           purposes (disregarded entity) mustn't 
Schedule M-3 Filing                        show tax-basis balance sheet amounts       be separately reported on Schedule M-3 
Requirements                               if the corporation is allowed to use       except, if required, on Part I, line 7a, 7b, 
If a corporation was required to file      books and records for Schedule M-3         or 7c. On Schedule M-3, Parts II and III, 
Schedule M-3 for the preceding tax         and the corporation's books and records    any item of income, gain, loss, 
year, but reports on Form 1120-S,          reflect only tax-basis amounts.            deduction, or credit of a disregarded 
                                                                                      entity must be reported as an item of its 
Schedule L, total assets at the end of     Generally, total assets at the             owner. In particular, the income or loss 
the current tax year of less than $10      beginning of the year (Schedule L,         of a disregarded entity mustn't be 
million, the corporation isn't required to line 15, column (b)) must equal total      reported on Part II, line 7, 8, or 9 as from 
file Schedule M-3 for the current tax      assets at the close of the prior year      a separate partnership or other 
year.                                      (Schedule L, line 15, column (d)). For     pass-through. The financial statement 
For purposes of determining whether        each Schedule L balance sheet item         income or loss of a disregarded entity 
the corporation has total assets at the    reported for which there is a difference   other than a qualified subchapter S 
end of the current tax year of $10 million between the current opening balance        subsidiary (QSub) is included on Part I, 
or more, the corporation's total assets    sheet amount and the prior closing         line 7b, if and only if its financial 
must be determined on an overall           balance sheet amount, attach a             statement income or loss is included on 
accrual method of accounting unless        statement that reports the balance sheet   Part I, line 11, but not on Part I, line 4a. 
both of the following apply: (a) the tax   item, the prior closing amount, the        The financial statement income or loss 
return of the corporation is prepared      current opening amount, and a short        of a QSub is included on Part I, line 7c, if 
using an overall cash method of            explanation of the difference. In          and only if its financial statement 
accounting, and (b) no includible entity   particular, indicate if the differences    income or loss is included on Part I, 
in the U.S. tax return prepares or is      occurred because of acquisitions or        line 11, but not on Part I, line 4a.
included in financial statements           mergers.                                   Qualified Subchapter S Subsidiaries 
prepared on an accrual basis.                                                         (QSubs).    Because a QSub is a 
                                           For purposes of measuring total 
                                                                                      disregarded entity, for purposes of 
      See the instructions for Part I,     assets at the end of the year, the 
                                                                                      Schedule M-3, Schedule L, and the tax 
TIP   line 1, for a discussion of          corporation's assets may not be netted 
                                                                                      return in general, the subsidiary is 
      non-tax-basis income                 or reduced by the corporation's 
                                                                                      deemed to have liquidated into the 
statements and related non-tax-basis       liabilities. In addition, total assets may 
                                                                                      parent S corporation. As such, all 
balance sheets to be used in the           not be reported as a negative amount. If 
                                                                                      QSubs are treated as divisions of the S 
preparation of Schedule M-3 and of         Schedule L is prepared on a 
                                                                                      corporation parent and they mustn't be 
Form 1120-S, Schedule L.                   non-tax-basis method, an investment in 
                                                                                      separately reported on Schedule M-3 
                                           a partnership may be shown as 
                                                                                      except, if required, on Part I, line 7c.
Other Form 1120-S                          appropriate under the corporation's 
                                           non-tax-basis method of accounting,        Reportable Entity Partner 
Schedules Affected by                      including, if required by the              Reporting Responsibilities
Schedule M-3                               corporation's reporting methodology, 
Requirements                               the equity method of accounting for        A reportable entity partner to a 
                                           investments. If Schedule L is prepared     partnership filing Form 1065, U.S. 
Schedule L                                 on a tax-basis method, an investment       Return of Partnership Income, is an 
If a non-tax-basis income statement and    by the corporation in a partnership must   entity that:
related non-tax-basis balance sheet is     be shown as an asset and measured by       • Owns or is deemed to own, directly or 
prepared for any purpose for a period      the corporation's adjusted basis in its    indirectly, under these instructions, a 
ending with or within the tax year,        partnership interest. Any liabilities      50% or greater interest in the income, 
Schedule L must be prepared showing        contributing to such adjusted basis must   loss, or capital of the partnership on any 
non-tax-basis amounts. See the             be shown on Schedule L as corporate        day of the tax year; and
instructions for Part I, line 1, for a     liabilities. In any event, any investments • Was required to file Schedule M-3 on 
discussion of non-tax-basis income         or other assets reported on Schedule L     its most recently filed U.S. federal 
statements and related non-tax-basis       can never be reported as negative          income tax return or return of income 
balance sheets prepared for any            amounts.                                   filed prior to that day.
purpose and the impact on the selection                                                 For the purposes of these 
                                           Schedule M-1
of the income statement used for                                                      instructions:
Schedule M-3 and the related               A corporation that completes Parts II        1. The parent corporation of a 
non-tax-basis balance sheet amounts        and III of Schedule M-3 isn't required to  consolidated tax group is deemed to 
that must be used for Schedule L.          complete Form 1120-S, Schedule M-1.        own all corporate and partnership 

                                                       -2-                         Instructions for Schedule M-3 (Form 1120-S)

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interests owned or deemed to be owned The reportable entity partner must is deemed to have non-tax-basis
under these instructions by any member keep copies of required reports it makes income statements and the related
of the tax consolidated group; to partnerships under these instructions. non-tax-basis balance sheets for the
2. The owner of a disregarded entity Each partnership must keep copies of current tax year for purposes of
is deemed to own all corporate and the required reports it receives under Schedule M-3 and Schedule L if such
partnership interests owned or deemed these instructions from reportable entity non-tax-basis financial statements were
to be owned under these instructions by partners. prepared for and presented to
the disregarded entity; Example 2. A, a limited liability management, creditors, shareholders,
3. The owner of 50% or more of a company (LLC) filing a Form 1065 for its government regulators, or any other
corporation by vote on any day of the current tax year is owned 50% by U.S. third parties for a period ending with or
corporation tax year is deemed to own corporation Z which files Form 1120-S. within the tax year.
all corporate and partnership interests A owns 50% of each of B, C, D, and E,
owned or deemed to be owned under each also an LLC filing a Form 1065 for If a non-tax-basis income statement
these instructions by the corporation its current tax year. Z was first required is prepared that is a certified
during the corporation tax year; to file Schedule M-3 (Form 1120-S) for non-tax-basis income statement for the
its prior corporate tax year ended period ending with or within the tax year,
4. The owner of 50% or more of the corporation must check “Yes” for
partnership income, loss, or capital on December 31 and filed its Form 1120-S
any day of the partnership tax year is with Schedule M-3 on September 15. Part I, line 1a, and use that income
As of September 16, Z was a reportable statement for Schedule M-3. If no
deemed to own all corporate and certified non-tax-basis income
entity partner regarding A and, through
partnership interests owned or deemed statement is prepared but an unaudited
A, regarding B, C, D, and E. On October
to be owned under these instructions by non-tax-basis income statement is
5, Z reports to A, B, C, D, and E, as it is
the partnership during the partnership prepared for the period ending with or
tax year; and required to do within 30 days of
September 16, that Z is a reportable within the tax year, the corporation must
5. The beneficial owner of 50% or entity partner directly owning (regarding check “Yes” for Part I, line 1b, and use
more of the beneficial interest of a trust A) or deemed to own indirectly that income statement for
or nominee arrangement on any day of (regarding B, C, D, and E) a 50% Schedule M-3.
the trust or nominee arrangement tax interest. So, because Z was a Order of priority in accounting
year is deemed to own all corporate and reportable entity partner for its current standards. If two or more
partnership interests owned or deemed tax year, each of A, B, C, D, and E is non-tax-basis income statements are
to be owned under these instructions by required to file Schedule M-3 (Form both certified non-tax-basis income
the trust or nominee arrangement. 1065) for its current tax year, regardless statements for the period, the income
A reportable entity partner to a of whether they would otherwise be statement prepared according to the
partnership (as defined above) must required to file Schedule M-3 for that following order of priority in accounting
report the following to the partnership year. standards must be used.
within 30 days of first becoming a 1. U.S. Generally Accepted
reportable entity partner and, after first Specific Instructions Accounting Principles (GAAP).
reporting to the partnership under these 2. International Financial Reporting
instructions, after that within 30 days of for Part I
Standards (IFRS).
the date of any change in the interest it
owns or is deemed to own, directly or Part I. Financial 3. Any other International
Accounting Standards (IAS).
indirectly, under these instructions, in Information and Net
4. Other regulatory accrual
the partnership. Income (Loss) accounting.
1. Name. Reconciliation 5. Any other accrual accounting
2. Mailing address.
Line 1. Questions Regarding standard.
3. Taxpayer identification number
(TIN or EIN), if applicable. the Type of Income Statement 6. Any fair market value standard.
4. Entity or organization type. Prepared 7. Any cash basis standard.
5. State or country in which it is For Part I, lines 1 through 12, use only If no non-tax-basis income statement
organized. the financial statements of the U.S. is certified and two or more
corporation filing the U.S. income tax non-tax-basis income statements are
6. Date on which it first became a return. prepared, the income statement
reportable entity partner.
prepared according to the first listed of
7. Date for which it is reporting a Non-Tax-Basis Financial the accounting standards listed above
change in its ownership interest in the must be used.
Statements and Tax-Basis
partnership, if applicable.
Financial Statements
8. The interest in the partnership it If no non-tax-basis financial
owns or is deemed to own in the A tax-basis income statement is allowed statements are prepared for a U.S.
partnership, directly or indirectly (as for Schedule M-3 and a tax-basis corporation filing Schedule M-3 (Form
defined under these instructions) as of balance sheet for Schedule L only if no 1120-S), the U.S. corporation must
the date for which it is reporting. non-tax-basis income statement and no check “No” on questions 1a and 1b, skip
non-tax-basis balance sheet was
9. Any change in that interest as of Part I, lines 2, 3a, and 3b, and enter the
prepared for any purpose and the books
the date for which it is reporting. net income (loss) per the books and
and records of the corporation reflect records of the U.S. corporation on Part I,
only tax-basis amounts. The corporation line 4a.

Instructions for Schedule M-3 (Form 1120-S) -3-

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Lines 2 and 3. Questions 2. International Financial Reporting For example, if the net income (after
Regarding Income Statement Standards (IFRS). consolidation and elimination entries) of
Period and Restatements 3. Tax basis. a nonincludible foreign
sub-consolidated group is being
Enter the beginning and ending dates 4. Other (Specify). reported on line 5a, the attached
on line 2 for the corporation's annual Report on Part I, lines 5a through 10, supporting statement should report the
income statement period ending with or as instructed below, all adjustment income (loss) of each separate
within the current tax year. amounts required to adjust worldwide nonincludible foreign legal entity from
The questions on Part I, lines 3a and net income (loss) reported on this Part I, each such entity's own financial
3b, regarding income statement line 4a (whether from financial accounting net income statement or
restatements refer to the worldwide statements or books and records), to books and records, and any
consolidated income statement issued net income (loss) of the corporation that consolidation or elimination entries (for
by the corporation filing the U.S. income must be reported on Part I, line 11. intercompany dividends, minority
tax return and used to prepare Report on line 12a the worldwide interests, etc.) not reportable on Part I,
Schedule M-3. Answer “Yes” on lines 3a consolidated total assets and total line 8, should be reported on the
and/or 3b if the corporation's annual liabilities amounts for the corporation attached supporting statement as a net
income statement has been restated for using the same financial statements (or amount on a line separate and apart
any reason. Attach a short explanation book and records) used for the from lines that report each nonincludible
of the reasons for the restatement in net worldwide consolidated income (loss) foreign entity's separate net income
income for each annual income amount reported on line 4a. (loss).
statement period that is restated, Line 6. Net Income (Loss) of
Line 5. Net Income (Loss) of
including the original amount and
restated amount of each annual Nonincludible Foreign Entities Nonincludible U.S. Entities
statement period's net income. Remove the financial net income Remove the financial net income
(line 5a) or loss (line 5b) of each foreign (line 6a) or loss (line 6b) of each U.S.
Line 4. Worldwide Consolidated entity that is included on line 4a and isn't entity that is included on line 4a and isn't
Net Income (Loss) per Income an includible entity in the U.S. tax return an includible entity in the U.S. tax return
Statement (nonincludible foreign entity). In (nonincludible U.S. entity). In addition,
Report on Part I, line 4a, the worldwide addition, on Part I, line 8, adjust for on Part I, line 8, adjust for consolidation
consolidated net income (loss) per the consolidation eliminations and correct eliminations and correct for minority
income statement (or books and for minority interest and intercompany interest and intercompany dividends
records, if applicable) of the dividends between any nonincludible between any nonincludible U.S. entity
corporation. foreign entity and the entity filing Form and any includible entity. Don't remove
1120-S. Don't remove in Part I the in Part I the financial net income (loss)
In completing Schedule M-3, the financial net income (loss) of any of any nonincludible U.S. entity
corporation must use financial nonincludible foreign entity accounted accounted for on line 4a using the
statement amounts from the financial for on line 4a using the equity method. equity method.
statement type checked “Yes” on Part I,
line 1, or from its books and records if Attach a supporting statement that Attach a supporting statement that
Part I, line 1b, is checked “No.” provides the name, EIN (if applicable), provides the name, EIN, and net income
and net income (loss) included on (loss) included on line 4a that is
If a corporation prepares
line 4a that is removed on this line 5 for removed on this line 6 for each separate
non-tax-basis financial statements, the
each separate nonincludible foreign nonincludible U.S. entity. Also state the
amount on line 4a must equal the
entity. Also state the total assets and total assets and total liabilities for each
financial statement net income (loss) for
total liabilities for each such separate such separate nonincludible U.S. entity
the income statement period ending
nonincludible foreign entity and include and include those assets and liabilities
with or within the tax year as indicated
those assets and liabilities amounts in amounts in the total assets and total
on Part I, line 2.
the total assets and total liabilities liabilities reported on Part I, line 12c.
If the corporation prepares reported on Part I, line 12b. The The amounts of income (loss) detailed
non-tax-basis financial statements and amounts of income (loss) detailed on on the supporting statement should be
the income statement period differs the supporting statement should be reported for each separate
from the corporation's tax year, the reported for each separate nonincludible U.S. entity without regard
income statement period indicated on nonincludible foreign entity without to the effect of consolidation or
Part I, line 2, applies for purposes of regard to the effect of consolidation or elimination entries. If there are
Part I, lines 4 through 8. elimination entries. If there are consolidation or elimination entries
If the corporation doesn't prepare consolidation or elimination entries relating to nonincludible U.S. entities
non-tax-basis financial statements and relating to nonincludible foreign entities whose income (loss) is reported on the
has checked “No” on Part I, line 1b, whose income (loss) is reported on the attached statement that aren't
enter the net income (loss) per the attached statement that aren't reportable on Part I, line 8, the net
books and records of the U.S. reportable on Part I, line 8, the net amounts of all such consolidation and
corporation on Part I, line 4a. amounts of all such consolidation and elimination entries must be reported on
elimination entries must be reported on a separate line on the attached
Indicate on Part I, line 4b, which of a separate line on the attached statement, so that the separate financial
the following accounting standards were statement, so that the separate financial accounting income (loss) of each
used for line 4a. accounting income (loss) of each nonincludible U.S. entity remains
1. U.S. Generally Accepted nonincludible foreign entity remains separately stated. For example, if the
Accounting Principles (GAAP). separately stated. net income (after consolidation and

-4- Instructions for Schedule M-3 (Form 1120-S)

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elimination entries) of a nonincludible        the total assets and total liabilities     Include on Part I, line 8, the total of 
U.S. sub-consolidated group is being           reported on Part I, line 12d. The          the following: (a) amounts of any 
reported on line 6a, the attached              amounts of income (loss) detailed on       adjustments to consolidation entries 
supporting statement should report the         the supporting statement should be         and elimination entries that are 
income (loss) of each separate                 reported for each separate other           contained in the amount reported on 
nonincludible U.S. legal entity from each      disregarded entity or other QSub           Part I, line 4a, required as a result of 
such entity's own financial accounting         without regard to the effect of            removing amounts on Part I, line 5 or 6; 
net income statement or books and              consolidation or elimination entries       and (b) amounts of any additional 
records, and any consolidation or              solely between or among the entities       consolidation entries and elimination 
elimination entries (for intercompany          listed. If there are consolidation or      entries that are required as a result of 
dividends, minority interests, etc.) not       elimination entries relating to such other including amounts on Part I, line 7a, 7b, 
reportable on Part I, line 8, should be        disregarded entities or other QSub         or 7c. This is necessary in order that the 
reported on the attached supporting            whose income (loss) is reported on the     consolidation entries and intercompany 
statement as a net amount on a line            attached statement that aren't             elimination entries included in the 
separate and apart from lines that report      reportable on Part I, line 8, the net      amount reported on Part I, line 11, are 
each nonincludible U.S. entity's               amounts of all such consolidation and      only those applicable to the financial net 
separate net income (loss).                    elimination entries must be reported on    income (loss) of includible entities for 
                                               a separate line on the attached            the financial statement period. For 
Lines 7a, 7b, and 7c. Net                      statement, so that the separate financial  example, adjustments must be reported 
Income (Loss) of Other Foreign                 accounting income (loss) of each other     on line 8 to remove minority interest and 
Disregarded Entities, Net                      disregarded entity or other QSub           to reverse the elimination of 
Income (Loss) of Other                         remains separately stated. For example,    intercompany dividends included on 
                                               if the net income (after consolidation     Part I, line 4a, that relate to the net 
Disregarded Entities (Except 
                                               and elimination entries) of a              income of entities removed on Part I, 
Qualified Subchapter S                         sub-consolidated group of other            line 5 or 6, because the income to which 
Subsidiaries), and Net Income                  disregarded entities is being reported     the consolidation or elimination entries 
(Loss) of Other Qualified                      on line 7b, the attached supporting        relate has been removed. Also, for 
Subchapter S Subsidiaries                      statement should report the income         example, consolidation or elimination 
                                               (loss) of each separate other              entries must be reported on line 8 to 
(QSubs)                                        disregarded entity from each entity's      eliminate any intercompany dividends 
Include on line 7a the financial income        own financial accounting net income        between entities whose income is 
of any foreign disregarded entity that         statement or books and records, and        included on Part I, line 7a, 7b, or 7c, and 
isn't included on Part I, line 4a, but is      any consolidation or elimination entries   other entities included in the U.S. 
included in Part I, line 11 (other foreign     (for intercompany dividends, minority      income tax return. See Example 3A 3B,      , 
disregarded entities). Include on line 7b      interests, etc.) not reportable on Part I, and   in the instructions for line 11.4
or 7c the financial net income or (loss)       line 8, should be reported on the          If a corporate owner of an interest in 
of each disregarded entity in the U.S.         attached supporting statement as a net     another entity: (a) accounts for the 
tax return that isn't included in the          amount on a line separate and apart        interest in entity in the owner 
consolidated financial group and               from lines that report each other          corporation's separate general ledger 
therefore not included in the income           disregarded entity's separate net          on the equity method, and (b) fully 
reported on Part I, line 4a. Include on        income (loss).                             consolidates entity in the owner 
line 7b the financial income of any U.S. 
disregarded entity that isn't a qualified      Line 8. Adjustment to                      corporation's consolidated financial 
subchapter S subsidiary (QSub) or a            Eliminations of Transactions               statements, but entity isn't includible in 
                                                                                          the owner corporation's U.S. income tax 
foreign disregarded entity and that isn't      Between Includible Entities and            return, then, as part of reversing all 
included in the income reported on Part 
                                               Nonincludible Entities
I, line 4a, but is included in Part I, line 11                                            consolidation and elimination entries for 
(other disregarded entities). Include on       Adjustments on Part I, line 8, to reverse  the nonincludible entity, the corporate 
line 7c the financial income of any QSub       certain financial accounting               owner must reverse on Schedule M-3, 
that isn't included in the income              consolidation or elimination entries are   Part I, line 8, the elimination of the equity 
reported on line 4a, but is included on        necessary to ensure that transactions      income inclusion from entity. If the 
line 11 (other QSub). In addition, on Part     between includible entities and            owner corporation doesn't account for 
I, line 8, adjust for consolidation            nonincludible U.S. or foreign entities     entity on the equity method on its own 
eliminations and correct for minority          aren't eliminated, in order to report the  general ledger, it won't have eliminated 
interest and intercompany dividends for        correct total amount on Part I, line 11.   the equity income for consolidated 
any other disregarded entity or other          Also, additional consolidation entries     financial statement purposes, so it will 
QSub.                                          and elimination entries may be             have no elimination of equity income to 
                                               necessary on Part I, line 8, related to    reverse.
Attach a supporting statement that             transactions between includible entities   The attached supporting statement 
provides the name, EIN, and net income         that are in the consolidated financial     for Part I, line 8, must identify the type 
(loss) per the financial statement or          group and other disregarded entities       (for example, minority interest, 
books and records on this line 7 for           and QSubs that aren't in the               intercompany dividends, etc.) and 
each separate other disregarded entity         consolidated financial group but that are  amount of consolidation or elimination 
or other QSub. Also state the total            reported on Part I, line 7a, 7b, or 7c, in entries reported, as well as the names 
assets and total liabilities for each such     order to report the correct total amount   of the entities to which they pertain. It 
separate included entity and include           on Part I, line 11.                        isn't necessary, but it is permitted, to 
those assets and liabilities amounts in                                                   report intercompany eliminations that 

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net to zero on Part I, line 8, such as entries (including workpaper in the net income amount on line 4a
intercompany interest income and adjustments) and dividend income or remain eliminated in the net income
expense. other income received from amount on line 11. Transactions
nonincludible entities. If the corporation between the corporation and the
Line 9. Adjustment To prepares unconsolidated financial nonincludible entities that are eliminated
Reconcile Income Statement statements using the same accounting in the net income amount on line 4a are
Period to Tax Year method used to determine worldwide included in the net income amount on
Include on line 9 any adjustments consolidated net income (loss) for Part I, line 11 since the elimination of those
necessary to the income (loss) of line 4a, and if it uses the equity method transactions were reversed on line 8.
includible entities to reconcile for investments, the amount reported on Example 3B.
differences between the corporation's Part I, line 11, will equal the amount of
income statement period reported on the unconsolidated net income (loss) 1. U.S. corporation P owns 60% of
line 2 and the corporation's tax year. reported on the unconsolidated financial corporation DS1 which is fully
Attach a statement describing the statements. See items 3 and 4 under consolidated in P's financial statements.
adjustment. Example 3B, later. P doesn't account for DS1 in P's
separate general ledger on the equity
Example 3A. U.S. corporation P
Line 10. Other Adjustments To method. DS1 has net income of $100
files a Form 1120-S U.S. tax return and (before minority interests) and pays
Reconcile to Amount on Line 11 prepares certified audited income dividends of $50, of which P receives
Include on line 10 any other statements for GAAP. P owns 100% of $30. The dividend is eliminated in the
adjustments to reconcile net income the stock of U.S. corporations DS1 consolidated financial statements. In its
(loss) on Part I, line 4a, through Part I, through DS75, between 51% and 99% financial statements, P consolidates
line 9, with net income (loss) on Part I, of the stock of U.S. corporations DS76 DS1 and includes $60 of net income
line 11. through DS100, and 100% of the stock ($100 less the minority interest of $40)
For any adjustments reported on Part of foreign entities FS1 through FS50. P on Part I, line 4a.
I, line 10, attach a supporting statement eliminates all dividend income from DS1
with an explanation of each net through DS100 and FS1 through FS50 P must remove the $100 net income
adjustment included on line 10. in financial statement consolidation of DS1 on Part I, line 6a. P must reverse
entries. Furthermore, P eliminates the on Part I, line 8, the elimination of the
Line 11. Net Income (Loss) per minority interest ownership, if any, of $40 minority interest net income of DS1.
Income Statement of the DS76 through DS100 in financial In addition, P reverses its elimination of
Corporation statement consolidation entries. the $30 intercompany dividend in its
financial statements on Part I, line 8.
Report on line 11 the net income (loss) P must check “Yes” on Part I, line 1a. The net result is that P includes the $30
per the income statement (or books and On Part I, line 4a, P must report the dividend from DS1 at Part I, line 11, and
records, if applicable) of the consolidated net income for the on Part II, line 6, column (a). P's
corporation. Amounts reported in consolidated financial statement group dividend income included on the tax
column (a) of Parts II and III (see later) of P, DS1 through DS100, and FS1 return from DS1 must be reported on
must be reported on the same through FS50. P must remove the net Part II, line 6, column (d).
accounting method used to report the income (loss) of FS1 through FS50 on
amount of net income (loss) per income Part I, line 5a or 5b, as applicable, and 2. U.S. corporation C owns 60% of
statement of the corporation on Part I, remove on Part I, line 6a or 6b, as the capital and profits interests in U.S.
line 11. applicable, any net income (loss) from LLC N. C doesn't account for N in C's
DS1 through DS75 where a QSub separate general ledger on the equity
Don't, in any event, report on this election hasn't been made by P. P must method. N has net income of $100
line 11 the net income of entities not remove the net income (loss) before (before minority interests) and makes no
included in the U.S. income tax return minority interests of DS76 through distributions during the tax year. C
for the tax year. For example, it isn't DS100 on Part I, line 6a or 6b, as treats N as a corporation for financial
permissible to remove the income of applicable. P must reverse on Part I, statement purposes and as a
nonincludible entities on lines 5 and/or line 8, the elimination of any partnership for U.S. income tax
6, above, then to add back such income transactions between the includible purposes. In its financial statements, C
on lines 7 through 10, such that the entity (P and any QSubs) and the consolidates N and includes $60 of net
amount reported on line 11 includes the nonincludible entities (DS1 through income ($100 less the minority interest
net income of entities not includible in DS75 with no QSub election, DS76 of $40) on Part I, line 4a.
the U.S. income tax return. A principal through DS100 and FS1 through FS50), C must remove the $100 net income
purpose of Schedule M-3 is to report on including dividends received from of N on Part I, line 6a. C must reverse on
this Part I, line 11, only the financial non-QSub DS1 through DS75, DS76 Part I, line 8, the elimination of the $40
accounting net income of only the through DS100, and FS1 through FS50 minority interest net income of N. The
entities included in the U.S. income tax and the minority interest's share of the result is that C includes no income for N
return. net income (loss) of DS76 through either on Part I, line 11, or on Part II,
Whether or not the corporation DS100. line 7, column (a). C's taxable income
prepares financial statements, Part I, P reports on Part I, line 11, the from N must be reported by C on Part II,
line 11, must include all items that consolidated financial statement net line 7, column (d).
impact the net income (loss) of the income (loss) attributable to the 3. U.S. corporation P owns 60% of
corporation even if they aren't recorded corporation and QSubs. Intercompany corporation DS1, which is fully
in the profit and loss accounts in the transactions between the corporation consolidated in P's financial statements.
corporation's general ledger, including, and the QSubs that had been eliminated P accounts for DS1 in P's separate
for example, all post-closing adjusting general ledger on the equity method.

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DS1 has net income of $100 (before DS1 is a QSub, 100% of the net income
minority interests) and pays dividends of of both P and DS1 must be reported on Specific Instructions for
$50, of which P receives $30. The Form 1120-S of P's U.S. income tax Parts II and III
dividend reduces P's investment in DS1 return, and the intercompany interest
for equity method reporting on P's income and expense must be removed General Reporting information
separate general ledger where P by consolidation elimination entries. A schedule or statement may be
includes its 60% equity share of DS1 P must report its financial statement attached to any line even if none is
income, which is $60. In its financial net income of $1,040 on Part I, line 4a, required.
statements, P eliminates the DS1 equity and reports DS1's net income of $100
method income of $60 and consolidates on Part I, line 7c. Then, in order to For each line item in Parts II and III,
DS1, including $60 of net income ($100 reflect the full consolidation of the report in column (a) the amount of net
less the minority interest of $40) on Part financial accounting net income of P income (loss) included in Part I, line 11,
I, line 4a. and DS1 at Part I, line 11, the following and report in column (d) the amount
P must remove the $100 net income consolidation and elimination entries are included in total income (loss) on Form
of DS1 on Part I, line 6a. P must reverse reported on Part I, line 8: offsetting 1120-S, Schedule K, line 18.
on Part I, line 8, the elimination of the entries to remove the $40 of interest Part II, line 26, column (a) must
$40 minority interest net income of DS1 income received from DS1 included by TIP equal Part I, line 11, and column
and the elimination of the $60 of DS1 P on line 4a, and to remove the $40 of (d) must equal the amount on
equity income. The net result is that P interest expense of DS1 included in Form 1120-S, Schedule K, line 18.
includes the $60 of equity method line 7c for a net change of zero. The
income from DS1 at Part I, line 11, and result is that Part I, line 11, reports For any item of income, gain, loss,
on Part II, line 5, column (a). P's $1,140: $1,040 from line 4a, and $100 expense, or deduction for which there is
dividend income included on the tax from line 7c. Stated another way, Part I, a difference between columns (a) and
return from its investment in DS1 must line 11, includes the entire $1,000 net (d), the portion of the difference that is
be reported on Part II, line 6, column (d). income of P, measured before temporary must be entered in column
4. U.S. corporation C owns 60% of recognition of the intercompany interest (b) and the portion of the difference that
the capital and profits interests in U.S. income from DS1 and the consolidation is permanent must be entered in column
LLC N. C accounts for N in C's separate of DS1 operations, plus the entire $140 (c).
general ledger on the equity method. N net income of DS1, measured before
has net income of $100 (before minority interest expense to P. P's U.S. income If financial statements are prepared
interests) and makes no distributions tax group isn't required to include on the by the corporation under with generally
during the tax year. C treats N as a attached supporting statement for Part I, accepted accounting principles (GAAP),
corporation for financial statement line 8, the offsetting adjustment to the differences that are treated as
purposes and as a partnership for U.S. intercompany elimination of interest temporary under GAAP must be
income tax purposes. For equity method income and interest expense (though it reported in column (b) and differences
reporting on C's separate general is permitted to do so). that are permanent (that is, not
temporary) for GAAP must be reported
ledger, C includes its 60% equity share Line 12. Total Assets and in column (c). Generally, under to
of N income, which is $60. In its
financial statements, C eliminates the Liabilities of Entities Included GAAP, a temporary difference affects
$60 of N net income ($100 less the or Removed on Part I, Lines 4, (creates, increases, or decreases) a
minority interest of $40) on Part I, 5, 6, and 7 deferred tax asset or liability.
line 4a. Line 12 must be completed by all If the corporation doesn't prepare
C must remove the $100 net income corporations that file Schedule M-3. financial statements, or the financial
of N on Part I, line 6a. C must reverse on Report on lines 12a, 12b, 12c, and 12d statements aren't prepared under
Part I, line 8, the elimination of the $40 the total amount (not just the GAAP, report in column (b) any
minority interest net income of N and the corporation's share) of assets and difference that the corporation believes
elimination of the $60 of N equity liabilities of entities included or removed will reverse in a future tax year (that is,
method income. The result is that C on Part I, lines 4, 5, 6, and 7. All assets have an opposite effect on total income
includes the $60 of equity method and liabilities reported on lines 12a (loss) in a future tax year (or years) due
income for N on Part I, line 11, and on through 12d must be reported as to the difference in timing of recognition
Part II, line 7, column (a). C's taxable positive amounts. for financial accounting and U.S.
income from N must be reported by C income tax purposes) or is the reversal
On line 12a, enter the worldwide
on Part II, line 7, column (d). of such a difference that arose in a prior
consolidated total assets and total
Example 4. U.S. corporation P liabilities of all of the entities included in tax year. Report in column (c) any
owns 100% of the stock of QSub computing Part I, line 4a. On line 12b, difference that the corporation believes
corporation DS1. DS1 is included in P's enter the total assets and total liabilities won't reverse in a future tax year (and
federal income tax return, even though of the entities removed in completing isn't the reversal of such a difference
DS1 isn't included in P's consolidated Part I, line 5. On line 12c, enter the total that arose in a prior tax year).
financial statements on either a assets and total liabilities removed in
If the corporation is unable to
consolidated basis or on the equity completing Part I, line 6. On line 12d,
determine whether a difference between
method. DS1 has current year net enter total assets and total liabilities
column (a) and column (d) for an item
income of $100 after taking into account included in completing Part I, line 7.
will reverse in a future tax year or is the
its $40 interest payment to P. P has net reversal of a difference that arose in a
income of $1,040 after recognition of the prior tax year, report the difference for
interest income from DS1. Because that item in column (c).

Instructions for Schedule M-3 (Form 1120-S) -7-

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Example 5.        At the end of             amount would otherwise be reported on        Furthermore, in applying the two 
Corporation A's first tax year, it wasn't   Schedule M, Part II or Part III. So, if a    preceding paragraphs, a corporation is 
required to file Schedule M-3 for any       taxpayer is required to file Form 8886,      required to report in column (a) of Parts 
reason.                                     Reportable Transaction Disclosure            II and III the amount of any item 
A may elect to file Schedule M-3            Statement, the amounts attributable to       specifically listed on Schedule M-3 that 
instead of completing Schedule M-1.         that reportable transaction must be          is included in the corporation's financial 
                                            reported on Part II, line 10.                statements or exists in the corporation's 
If A elects to file schedule M-3, it                                                     books and records, regardless of the 
must either (i) complete Schedule M-3       A corporation is required to report in       nomenclature associated with that item 
entirely or (ii) complete Schedule M-3      column (a) of Parts II and III the amount    in the financial statements or books and 
through Part I and complete                 of any item specifically listed on           records. Accurate completion of 
Schedule M-1 instead of completing          Schedule M-3 that is in any manner           Schedule M-3 requires reporting 
Parts II and III of Schedule M-3.           included in the corporation's current        amounts according to the substantive 
If A elects to complete Schedule M-3        year financial statement net income          nature of the specific line items included 
entirely, it must complete all columns of   (loss) or in an income or expense            in Schedule M-3 and consistent 
Parts II and III.                           account maintained in the corporation's      reporting of all transactions of like 
If A completes Schedule M-3 through         books and records, even if there is no       substantive nature that occurred during 
Part I and completes Schedule M-1           difference between that amount and the       the tax year. For example, all expense 
instead of completing Parts II and III of   amount included in total income (loss)       amounts that are included in the 
Schedule M-3, line 11 of Part I of          unless ( ) otherwise provided in these a     financial statements or exist in the 
Schedule M-3 must equal line 1 of           instructions or ( ) the amount is b          books and records that represent some 
Schedule M-1.                               attributable to a reportable transaction     form of “Bad debt expense,” must be 
                                            described in Regulations section             reported on Part III, line 25, in column 
Example 6.        Corporation B is a U.S.   1.6011-4(b) so it is reported on Part II,    (a), regardless of whether the amounts 
corporation that files a U.S. tax return    line 10. For example, with the exception     are recorded or stated under different 
and prepares GAAP financial                 of interest income reflected on a            nomenclature in the financial 
statements. In prior years, B acquired      Schedule K-1 received by a corporation       statements or the books and records 
intellectual property (IP) and goodwill.    as a result of the corporation's             such as: “Provision for doubtful 
The IP is amortizable for both U.S.         investment in a partnership or other         accounts”; “Expense for uncollectible 
income tax and financial statement          pass-through entity, all interest income     notes receivable”; or “Impairment of 
purposes. In the current year, B's annual   included on Part I, line 11, whether from    trade accounts receivable.” Likewise, as 
amortization expense for IP is $9,000 for   affiliated companies, third parties,         stated in the preceding paragraph, all 
U.S. income tax purposes and $6,000         banks, or other entities, whether from       fines and penalties must be included on 
for financial statement purposes. In its    foreign or domestic sources, whether         Part III, line 9, column (a), regardless of 
financial statements, B treats the          taxable or exempt from tax, and whether      the terminology or nomenclature 
difference in IP amortization as a          classified as some other type of income      attached to them by the corporation in 
temporary difference. The goodwill isn't    for U.S. income tax purposes (such as        its books and records or financial 
amortizable for U.S. income tax             dividends), must be included on Part II,     statements.
purposes and is subject to impairment       line 11, column (a). Likewise, all fines 
for financial statement purposes. In the    and penalties included in Part I, line 11,   With limited exceptions, Part II 
current year, B records an impairment       paid to a government or other authority      includes lines for specific items of 
charge on the goodwill of $5,000. In its    for the violation of any law for which       income, gain, or loss (income items). 
financial statements, B treats the          fines or penalties are assessed must be      (See Part II, lines 1 through 21.) If an 
goodwill impairment as a permanent          included on Part III, line 9, column (a),    income item is described in Part II, lines 
difference. B must report the               regardless of the government authority       1 through 21, report the amount of the 
amortization attributable to the IP on      that imposed the fines or penalties,         item on the applicable line, regardless of 
Part III, line 21, and report $6,000 in     regardless of whether the fines or           whether there is a difference for the 
column (a), a temporary difference of       penalties are civil or criminal, regardless  item. If there is a difference for the 
$3,000 in column (b), and $9,000 in         of the classification, nomenclature, or      income item, or only a portion of the 
column (d). B must report the goodwill      terminology attached to the fines or         income item has a difference and a 
impairment on Part III, line 19, and        penalties by the imposing authority in its   portion of the item doesn't have a 
report $5,000 in column (a), a              actions or documents.                        difference, and the item isn't described 
permanent difference of ($5,000) in                                                      in Part II, lines 1 through 21, report and 
column (c), and $0 in column (d).           If a corporation would be required to        describe the entire amount of the item 
                                            report in column (a) of Parts II and III the on Part II, line 22.
Reporting Requirements                      amount of any item specifically listed on    With limited exceptions, Part III 
for Parts II and III                        Schedule M-3 in accordance with the          includes lines for specific items of 
                                            preceding paragraph, except that the         expense or deduction (expense items). 
General Reporting                           corporation has capitalized the item of      (See Part III, lines 1 through 28.) If an 
Requirements                                income or expense and reports the            expense item is described on Part III, 
If an amount is attributable to a           amount in its financial statement            lines 1 through 28, report the amount of 
reportable transaction described in         balance sheet or in asset and liability      the item on the applicable line, 
Regulations section 1.6011-4(b), the        accounts maintained in the                   regardless of whether there is a 
amount must be reported in columns          corporation's books and records, the         difference for the item. If there is a 
(a), (b), (c), and (d), as applicable, of   corporation must report the proper tax       difference for the expense item, or only 
Part II, line 10, regardless of whether the treatment of the item in columns (b), (c),   a portion of the expense item has a 
                                            and (d), as applicable.                      difference and a portion of the item 

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doesn't have a difference and the item in the financial statements or books and reserves are expenses in D's current
isn't described in Part III, lines 1 through records of the taxpayer, under which the financial statements but aren't
28, report and describe the entire amount in column (a) was recorded in deductions for U.S. income tax
amount of the item on Part III, line 31. the accounting records. Also, the purposes in its current tax years. D
If there is no difference between the description for each amount entered in mustn't combine the Schedule M-3
financial accounting amount and the column (a) must include detailed differences for the three reserve
taxable amount of an entire item of information supporting each adjustment accounts. D must report the amounts
income, loss, expense, or deduction reported in columns (b) and (c), attributable to the allowance for
and the item isn't described or included including how the adjustment is uncollectible accounts receivable on
in Part II, lines 1 through 21, or Part III, identified in the accounting records. The Part III, line 25, and must separately
lines 1 through 28, report the entire entire description is considered the tax state and adequately disclose the
amount of the item in columns (a) and description for the amount reported in amounts attributable to each of the
(d) of Part II, line 25. column (d) for each item reported on other two reserves, coupons
Part II, line 22, or Part III, line 31. outstanding and warranty costs, on a
Separately stated and adequately required, attached statement that
Each description should adequately
disclosed. Each difference reported in supports the amounts at Part III, line 31.
describe all four columns of Part II,
Parts II and III must be separately stated
line 22, or Part III, line 31. If additional D must also provide a description for
and adequately disclosed. In general, a
information is required to provide an each reserve that meets the
difference is adequately disclosed if the
acceptable description, provide a requirements for Part III, line 31,
difference is labeled in a manner that
supporting statement. discussed earlier under Required
clearly identifies the item or transaction
from which the difference arises. For Example 7. Corporation C is a statements for Part II, line 22, and Part
further guidance about adequate calendar year taxpayer that files and III, line 31. In this example, an
disclosure, see Regulations section entirely completes Schedule M-3 for its acceptable description would be
1.6662-4(f). If a specific item of income, current tax year. C placed in service 10 "Coupon Issue Reserves - Rewards
gain, loss, expense, or deduction is depreciable fixed assets in a previous Expense" and "Future Warranty
described on Part II, lines 7 through 21, year. C's total depreciation expense for Expense Reserve."
or Part III, lines 1 through 28, and the its current tax year for five of the assets There is no need to add the title
line doesn't indicate to “attach is $50,000 for income statement TIP of the reserve account to the
statement,” and the specific instructions purposes and $70,000 for U.S. income description if the account name
for the line don't call for an attachment tax purposes. C's total annual for the amount in column (a) is already
of a statement, then the item is depreciation expense for its current tax part of the adjustment description.
considered separately stated and year for the other five assets is $40,000
adequately disclosed if the item is for income statement purposes and Example 9. Corporation E is a
reported on the applicable line and the $30,000 for U.S. income tax purposes. calendar year taxpayer that files and
amount(s) of the item(s) are reported in In its financial statements, C treats the entirely completes Schedule M-3 for its
the applicable columns of the applicable differences between financial statement current tax year. On January 2 of its
line. See the instructions for Part II, lines and U.S. income tax depreciation current tax year, E establishes an
1 through 6, for specific additional expense as giving rise to temporary allowance for uncollectible accounts
information required to be provided for differences that will reverse in future receivable (bad debt reserve) of
these particular lines. years. C must combine all of its $100,000. During its current tax year, E
Except as otherwise provided, depreciation adjustments. Accordingly, increased the reserve by $250,000 for
differences for the same item must be C must report on Part III, line 24, for its additional accounts receivable that may
combined or netted together and current tax year income statement become uncollectible. Additionally,
reported as one amount on the depreciation expense of $90,000 in during its current tax year, E decreases
applicable line of Schedule M-3. column (a), a temporary difference of the reserve by $75,000 for accounts
However, differences for separate items $10,000 in column (b), and U.S. income receivable that were discharged in
mustn't be combined or netted together. tax depreciation expense of $100,000 in bankruptcy during its current tax year.
Each item (and corresponding amount column (d). The balance in the reserve account on
attributable to that item) must be Example 8. Corporation D is a December 31 of its current tax year is
separately stated and adequately calendar year taxpayer that files and $275,000. The $100,000 amount to
disclosed on the applicable line of entirely completes Schedule M-3 for its establish the reserve account and the
Schedule M-3, or any statement current tax year. On December 31, of its $250,000 to increase the reserve
required to be attached, even if the current tax year, D establishes three account are expenses on E's current tax
amounts are below a certain dollar reserve accounts in the amount of year financial statements but aren't
amount. $100,000 for each account. One deductible for U.S. income tax purposes
reserve account is an allowance for in its current tax year. However, the
Required statements for Part II, $75,000 decrease to the reserve is
accounts receivable that are estimated
line 22, and Part III, line 31. A deductible for U.S. income tax purposes
to be uncollectible. The second reserve
separate statement must be attached to in its current tax year. In its financial
is an estimate of coupons outstanding
Schedule M-3 (Form 1120-S) that statements, E treats the reserve
that may have to be paid. The third
includes a detailed description of each account as giving rise to a temporary
reserve is an estimate of future warranty
item and adjustment entered on Part II, difference that will reverse in future tax
expenses. In its financial statements, D
line 22, and Part III, line 31. years. E must report on Part III, line 25,
treats the three reserve accounts as
The description for each amount giving rise to temporary differences that for its current tax year income statement
entered in column (a) must be readily will reverse in future years. The three bad debt expense of $350,000 in
identifiable to the name of the account column (a), a temporary difference of

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($275,000) in column (b), and U.S. foreign corporations on Part II, lines 2 Also include on line 3 passive foreign
income tax bad debt expense of through 4, as applicable. investment company (PFIC)
$75,000 in column (d). mark-to-market gains and losses under
Line 2. Gross Foreign section 1296. Don't report such gains
Example 10. Corporation F is a Dividends Not Previously and losses on Part II, line 14.
calendar year taxpayer that files and
entirely completes Schedule M-3 for its Taxed
Line 4. Gross Foreign
current tax year. During its current tax Except as otherwise provided in this
year, F incurs $200 in meal expenses paragraph, report on line 2, column (d), Distributions Previously Taxed
and $100 in entertainment expenses the amount (before any withholding tax) Report on line 4, column (a), any
that F deducts in computing net income of any foreign dividends included in distributions received from foreign
per the income statement. All of the current year total income (loss) on Form corporations that were included in Part I,
$200 meal expense is subject to the 1120-S, Schedule K, line 18, and report line 11, and that were previously taxed
50% limitation under section 274(n). on line 2, column (a), the amount of for U.S. income tax purposes. For
The $100 of entertainment expenses is dividends from any foreign corporation example, include in column (a) amounts
disallowed as a deduction under section included in Part I, line 11. Don't report that are excluded from income under
274(a). In its financial statements, F on line 2 any amounts that must be sections 959 and 1293(c). Remove
treats the limitation on deductions for reported on Part II, line 3, or dividends such amount in column (b) or (c), as
meals and entertainment as a that were previously taxed and must be applicable. Report the full amount of the
permanent difference. Because meal reported on Part II, line 4. (See the distribution before any withholding tax.
and entertainment expenses are instructions below for Part II, lines 3 and Report withholding taxes on Part III,
specifically described in Part III, line 8, F 4.) Report withholding taxes on Part III, line 31, or Part II, line 25, as applicable.
must report all of its meal and line 31, or Part II, line 25, as applicable. Since previously taxed foreign
distributions aren't currently taxable,
entertainment expenses on this line, For any dividends reported on Part II, line 4, column (d), is shaded. Also, see
regardless of whether there is a line 2, that are received on a class of the instructions above for Part II, line 2.
difference. Accordingly, F must report voting stock of which the corporation
$300 in column (a), $200 in column (c), directly or indirectly owned 10% or more Line 5. Income (Loss) From
and $100 in column (d). F must report of the outstanding shares of that class at Equity Method U.S.
all meal and entertainment expenses, any time during the tax year, report on Corporations
whether allowed fully or subject to an attached supporting statement: (1)
Report on line 5, column (a), the
limitations, on Part III, line 8. No amount the name of the dividend payer, (2) the
financial income (loss) included in Part I,
should be reflected on Part II, line 25. payer's EIN (if applicable), (3) the class
line 11, for any U.S. corporation
of voting stock on which the dividend
accounted for on the equity method and
Part II. Reconciliation of was paid, (4) the percentage of the
remove such amount in column (b) or
Net Income (Loss) per class directly or indirectly owned, and
(c), as applicable. Report on Part II,
Income Statement of the (5) the amounts for columns (a) through
line 6, dividends received from any U.S.
(d).
Corporation With Total corporation accounted for on the equity
Income (Loss) per Return Line 3. Subpart F, QEF, and method.
Similar Income Inclusions
Lines 1 Through 9. Additional Line 6. U.S. Dividends Not
Report on line 3, column (d), the amount Eliminated in Tax Consolidation
Information for Each Entity included in income under section 951
Report on line 6, column (a), the amount
For any item reported on Part II, lines 1, (relating to Subpart F), the amount
of dividends included in Part I, line 11,
and 3 through 5, attach a supporting included in income under section 951A
that were received from any U.S.
statement that provides the name of the (relating to global intangible low-taxed
corporation. Report on line 6, column
entity for which the item is reported, the income (GILTI)), gains or other income
(d), the amount of any U.S. dividends
entity's EIN (if applicable), the type of inclusions resulting from elections under
included in total income (loss) on Form
entity (corporation, partnership, etc.), sections 1291(d)(2) and 1298(b)(1), and
1120-S, Schedule K, line 18.
and the item amounts for columns (a) any amount included in income
through (d). See the instructions for Part pursuant to section 1293 (relating to For any dividends included on Part II,
II, lines 2 and 6 through 9, for the qualified electing funds (QEFs)). The line 6, that are received on classes of
specific information required for those amount of Subpart F income voting stock in which the corporation
particular lines. corresponds to the total of the amounts directly or indirectly owned 10% or more
reported by the corporation on of the outstanding shares of that class at
Line 1. Income (Loss) From Schedule I, lines 1 through 4, of all any time during the tax year, report on
Equity Method Foreign Forms 5471, Information Return of U.S. an attached supporting statement for
Corporations Persons With Respect To Certain Part II, line 6: (1) the name of the
Report on line 1, column (a), the Foreign Corporations. The amount of dividend payer, (2) the payer's EIN (if
financial income (loss) included in Part I, QEF income corresponds to the total of applicable), (3) the class of voting stock
line 11, for any foreign corporation the amounts reported by the corporation on which the dividend was paid, (4) the
accounted for on the equity method and on all Forms 8621, Information Return percentage of the class directly or
remove such amount in column (b) or by a Shareholder of a Passive Foreign indirectly owned, and (5) the item
(c), as applicable. Report the amount of Investment Company or Qualified amounts for columns (a) through (d).
dividends received and other taxable Electing Fund. See Form 8621 and the
amounts received or includible from Instructions for Form 8621.

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Line 7. Income (Loss) From Line 9. Income (Loss) From supporting statement for Part II, line 10,
U.S. Partnerships and Line 8. Other Pass-Through Entities each sequentially numbered reportable
transaction and the amounts required
Income (Loss) From Foreign For any interest in a pass-through entity for Part II, line 10, columns (a) through
Partnerships (other than an interest in a partnership (d).
For any interest owned by the reportable on Part II, line 7 or 8, as
corporation that is treated as an applicable) owned by the corporation In lieu of the requirements of the
investment in a partnership for U.S. (other than an interest in a disregarded preceding paragraph, a corporation will
income tax purposes (other than an entity), report the following on line 9. be considered to have separately stated
interest in a disregarded entity), report 1. In column (a), the sum of the and adequately disclosed a reportable
amounts on Part II, line 7 or 8, as corporation's distributive share of transaction if the corporation attaches a
described below. income or loss from the pass-through supporting statement that provides the
1. In column (a), the sum of the entity that is included in Part I, line 11. following for each reportable
corporation's distributive share of 2. In column (b) or (c), as transaction.
income or loss from a U.S. or foreign applicable, the sum of all differences, if 1. A description of the reportable
partnership that is included in Part I, any, attributable to the pass-through transaction disclosed on Form 8886 for
line 11. entity. which amounts are reported on Part II,
2. In column (b) or (c), as 3. In column (d), the sum of all line 10.
applicable, the sum of all differences, if taxable amounts of income, gain, loss, 2. The name and reportable
any, attributable to the corporation's or deduction reportable on the transaction or tax shelter registration
distributive share of income or loss from corporation's Schedules K-1 received number, if applicable, as reported on
a U.S. or foreign partnership. from the pass-through entity (if lines 1a and 1c, respectively, of Form
3. In column (d), the sum of all applicable). 8886.
amounts of income, gain, loss, or For each pass-through entity 3. The type of reportable transaction
deduction attributable to the reported on line 9, attach a supporting (that is, listed transaction, confidential
corporation's distributive share of statement that provides that entity's transaction, transaction with contractual
income or loss from a U.S. or foreign name, EIN (if applicable), the protection, etc.) as reported on line 2 of
partnership (that is, the sum of all corporation's end of year profit-sharing Form 8886.
amounts reportable on the corporation's percentage (if applicable), the If a transaction is a listed transaction
Schedule(s) K-1 received from the corporation's end of year loss-sharing described in Regulations section
partnership (if applicable)), without percentage (if applicable), and the 1.6011-4(b)(2), the description also
regard to any limitations computed at amounts reported by the corporation in must include the description provided
the partner level. column (a), (b), (c), or (d) of line 9, as on line 3 of Form 8886. In addition, if the
For each partnership reported on applicable. reportable transaction involves an
line 7 or 8, attach a supporting Line 10. Items Relating to investment in the transaction through
another entity such as a partnership, the
statement that provides the name, EIN Reportable Transactions description must include the name and
(if applicable), end of year profit-sharing
percentage (if applicable), end of year Any amounts attributable to any EIN (if applicable) of that entity as
loss-sharing percentage (if applicable), reportable transactions (as described in reported on line 5 of Form 8886.
and the amount reported in column (a), Regulations section 1.6011-4(b)) must
(b), (c), or (d) of lines 7 or 8, as be included on Part II, line 10, Example 12. Corporation J is a
applicable. regardless of whether the difference, or calendar year taxpayer that files and
differences, would otherwise be entirely completes Schedule M-3 for its
Example 11. U.S. corporation H is a reported elsewhere in Part II or Part III. current tax year. J incurred seven
calendar year taxpayer that files and So, if a taxpayer is required to file Form different abandonment losses during its
entirely completes Schedule M-3 for its 8886 for any reportable transaction current tax year. One loss of $12 million
current tax year. H has an investment in described in Regulations section results from a reportable transaction
a U.S. partnership USP. H prepares 1.6011-4(b), the amounts attributable to described in Regulations section
financial statements in accordance with that reportable transaction must be 1.6011-4(b)(5), another loss of $5
GAAP. In its financial statements, H reported on Part II, line 10. In addition, million results from a reportable
treats the difference between financial all income and expense amounts transaction described in Regulations
statement net income and taxable attributable to a reportable transaction section 1.6011-4(b)(4), and the
income from its investment in USP as a must be reported on Part II, line 10, remaining five abandonment losses
permanent difference. For its current tax columns (a) and (d), even if there is no aren't reportable transactions. J
year, H's financial statement net income difference between the financial discloses the reportable transactions
includes $10,000 of income attributable amounts and the taxable amounts. giving rise to the $12 million and $5
to its share of USP's net income. H's million losses on separate Forms 8886
Schedule K-1 from USP reports $5,000 Each difference attributable to a and sequentially numbers them X1 and
of ordinary income, $7,000 of long-term reportable transaction must be X2, respectively. J must separately state
capital gains, $4,000 of charitable separately stated and adequately and adequately disclose the $12 million
contributions, and $200 of section 179 disclosed. A corporation will be and $5 million losses on Part II, line 10.
expense. H must report on Part II, line 7, considered to have separately stated The $12 million loss and the $5 million
$10,000 in column (a), a permanent and adequately disclosed a reportable loss will be adequately disclosed if J
difference of ($2,200) in column (c), and transaction on line 10 if the corporation attaches a supporting statement for
$7,800 in column (d). sequentially numbers each Form 8886 line 10 that lists each of the sequentially
and lists by identifying number on the numbered forms, Form 8886-X1 and

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Form 8886-X2, and for each reportable files a Schedule M-3, isn't required to current tax year report accounts
transaction reports the appropriate file Form 8916-A but may voluntarily do receivable of $35,000, an allowance for
amounts required for Part II, line 10, so. bad debts of $10,000, and accounts
columns (a) through (d). Alternatively, payable of $17,000 related to current
J's disclosures will be adequate if the Report on Part II, line 11, column (a), year acquisition and reorganization
description provided for each loss on the total amount of interest income legal and accounting fees. In addition,
the supporting statement includes the included on Part I, line 11, and report on for L's year ending December 31 of its
names and reportable transaction or tax Part II, line 11, column (d), the total current tax year, L reported financial
shelter registration numbers, if any, amount of interest income included on statement depreciation expense of
disclosed on the applicable Form 8886, Form 1120-S, Schedule K, line 18, that $15,000 and depreciation for U.S.
identifies the type of reportable isn't required to be reported elsewhere income tax purposes of $25,000. For L's
transaction for the loss, and reports the on Schedule M-3. In columns (b) or (c), current tax year using an overall cash
appropriate amounts required for Part II, as applicable, adjust for any amounts method of accounting, L doesn't
line 10, columns (a) through (d). J must treated for U.S. income tax purposes as recognize the $35,000 of revenue
report the losses attributable to the interest income that are treated as some attributable to the accounts receivable,
other five abandonment losses on Part other form of income for financial can't deduct the $10,000 allowance for
II, line 21e, regardless of whether a accounting purposes, or vice versa. For bad debt, and can't deduct the $17,000
difference exists for any or all of those example, adjustments to interest of accounts payable. In its financial
abandonment losses. income resulting from adjustments statements, L treats both the difference
Example 13. Corporation K is a made in accordance with the in overall accounting methods used for
calendar year taxpayer that files and instructions for Part II, line 16, should be financial statement and U.S. income tax
entirely completes Schedule M-3 for its made in columns (b) and (c) of this purposes and the difference in
current tax year. K enters into a line 11. depreciation expense as temporary
transaction with contractual protection Don't report on this line 11 or include differences. L must combine all
that is a reportable transaction on Form 8916-A amounts reported in adjustments attributable to the
described in Regulations section accordance with instructions for Part II, differences related to the overall
1.6011-4(b)(4). This reportable lines 7, 8, 9, 10, and 20. accounting methods on Part II, line 12.
transaction is the only reportable As a result, L must report on Part II,
transaction for K's current tax year and Line 12. Total Accrual to Cash line 12, $8,000 in column (a) ($35,000 –
results in a $7 million capital loss for Adjustment $10,000 – $17,000), ($8,000) in column
both financial accounting purposes and This line is completed by a corporation (b), and zero in column (d). L mustn't
U.S. income tax purposes. Although the that prepares financial statements (or report the accrual to cash adjustment
transaction doesn't result in a books and records, if permitted) using attributable to the legal and accounting
difference, K is required to report on an overall accrual method of accounting fees on Part III, line 17. Because the
Part II, line 10, the following amounts: and uses an overall cash method of difference in depreciation expense
($7 million) in column (a), zero in accounting for U.S. income tax doesn't relate to the use of the cash or
columns (b) and (c), and ($7 million) in purposes (or vice versa). With the accrual method of accounting, L must
column (d). The transaction will be exception of amounts required to be report the depreciation difference on
adequately disclosed if K attaches a reported on Part II, line 10, the Part III, line 24, and report $15,000 in
supporting statement for line 10 that (a) corporation must report on Part II, column (a), $10,000 in column (b), and
sequentially numbers the Form 8886 line 12, a single amount net of all $25,000 in column (d).
and refers to the sequentially-numbered adjustments attributable solely to the Line 13. Hedging Transactions
Form 8886-X1 and (b) reports the use of the different overall methods of Report on line 13, column (a), the net
applicable amounts required for line 10, accounting (for example, adjustments gain or loss from hedging transactions
columns (a) through (d). Alternatively, related to accounts receivable, included on Part I, line 11. Report in
the transaction will be adequately accounts payable, compensation, column (d) the amount of income (loss)
disclosed if the supporting statement for accrued liabilities, etc.), regardless of from hedging transactions as defined in
line 10 includes a description of the whether a separate line on section 1221(b)(2). Use columns (b)
transaction, the name and tax shelter Schedule M-3 corresponds to an item and (c) to report all differences caused
registration number, if any, and the type within the accrual to cash reconciliation. by treating hedging transactions
of reportable transaction disclosed on Differences not attributable to the use of differently for financial accounting
Form 8886. the different overall methods of purposes and for U.S. income tax
accounting must be reported on the purposes. For example, if a portion of a
Line 11. Interest Income appropriate lines of Schedule M-3 (for hedge is considered ineffective under
Attach Form 8916-A, Supplemental example, a depreciation difference must GAAP but still is a valid hedge under
Attachment to Schedule M-3. Complete be reported on Part III, line 24). section 1221(b)(2), the difference must
Part II and enter the amounts shown on
line 6, columns (a) through (d), on Example 14. Corporation L is a be reported on line 13. The hedge of a
Schedule M-3, line 11, columns (a) calendar year taxpayer that files and capital asset, which isn't a valid hedge
through (d), as applicable. entirely completes Schedule M-3 for its for U.S. income tax purposes but may
current tax year. L prepares financial be considered a hedge for GAAP
Any corporation that files Form statements in accordance with GAAP purposes, must also be reported here.
TIP 1120-S that (a) is required to file using an overall accrual method of
a Schedule M-3 and has less accounting. L uses an overall cash Report hedging gains and losses
than $50 million in total assets at the method of accounting for U.S. income computed under the mark-to-market
end of the tax year or (b) isn't required tax purposes. L's financial statements method of accounting on line 13 and not
to file a Schedule M-3 and voluntarily for the year ending December 31 of its on Part II, line 14.

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Report any gain or loss from (including depreciation) such as section purposes and $30,000 for U.S. income
inventory hedging transactions on 263A costs, inventory shrinkage tax purposes. In addition, C incurs $200
line 13 and not on Part II, line 15. accruals, inventory obsolescence of meal expenses that C deducts in
reserves, and lower of cost or market computing net income for financial
Line 14. Mark-to-Market Income (LCM) write-downs. accounting purposes. All $200 of the
(Loss) meal expenses is subject to the 50%
Complete Part I of Form 8916-A.
Report on line 14 any amount Enter the amounts from line 8, columns limitation under section 274(n). In its
representing the mark-to-market income (a) through (d) of Form 8916-A, on financial statements, C treats the
or loss for any securities held by a Schedule M-3, Part II, line 15, columns $50,000 depreciation and $100 of the
dealer in securities, a dealer in (a) through (d), as applicable. Attach meals as other costs in computing cost
commodities having made a valid Form 8916-A. of goods sold. C must include on
election under section 475(e), or a Schedule M-3, Part II, line 15, in column
trader in securities or commodities The entries in columns (a) and (a), the $50,000 of depreciation and
having made a valid election under TIP (d) of Schedule M-3, line 15, are $100 of meals. C must also include a
section 475(f). “Securities” for these negative amounts. temporary difference of $20,000 in
purposes are securities described in column (b), a permanent difference of
section 475(c)(2) and “commodities” are Don't report the following on line 15 ($50) in column (c), and $70,050 in
described in section 475(e)(2). or on Form 8916-A. column (d) ($70,000 depreciation and
“Securities” don't include any items • Amounts reportable on Part II, line 10. $50 meal expenses). In addition, C must
specifically excluded from sections • Any gain or loss from inventory report on Part III, line 24, for its current
475(c)(2) and 475(e)(2), such as certain hedging transactions reportable on Part tax year income statement, depreciation
contracts to which section 1256(a) II, line 13. expense of $40,000 in column (a), a
applies. • Amounts reportable on Part II, line 16. temporary difference of ($10,000) in
• Amounts reportable on Part II, line 19. column (b), and $30,000 in column (d);
Report hedging gains and losses • Mark-to-market income or (loss) and on Part III, line 8, meals and
computed under the mark-to-market associated with the inventories of entertainment expense of $100 in
method of accounting on Part II, line 13, dealers in securities under section 475 column (a), a permanent difference of
and not on line 14. reportable on Part II, line 14. ($50) in column (c), and $50 in column
Traders in securities and commodi- • Section 481(a) adjustments related to (d). All other cost of goods sold items
cost of goods sold or inventory valuation would be added to the amounts
ties. For a trader in securities or reportable on Part II, line 17. included on Part II, line 15, detailed in
under section 475(f) to use the •
commodities that made a valid election Fines and penalties reportable on this example and reported on Part II,
Part III, line 9. line 15, in the appropriate columns.
mark-to-market method to account for Judgments, damages, awards, and
securities or commodities held in •
similar costs, reportable on Part III, Line 16. Sale Versus Lease (for
connection with a trading business that line 10. Sellers and/or Lessors)
files Form 4797, Sales of Business Amounts included on Part III, line 28.
Property, any Schedule M-3 entries •
Also see the instructions at Part
required as a result of marking to market Form 8916-A. Any corporation filing TIP III, line 28.
these securities or commodities are Form 1120-S that (a) is required to file a
reported as follows: (a) mark-to-market Schedule M-3 and has less than $50 Asset transfer transactions with periodic
gains and losses from Form 4797, million in total assets at the end of the payments characterized for financial
line 10, are included on Schedule M-3 tax year or (b) isn't required to file a accounting purposes as either a sale or
(Form 1120-S), Part II, line 14; (b) any Schedule M-3 and voluntarily files a a lease may, under some
other Schedule M-3 entries required Schedule M-3, isn't required to file Form circumstances, be characterized as the
based on other results (non 8916-A but may voluntarily do so. opposite for tax purposes. If the
mark-to-market gains and losses) If you are required to (or voluntarily) transaction is treated as a lease, the
included in the total reported on Form file Form 8916-A, complete Part I to seller/lessor reports the periodic
4797, line 17, should be reported on provide a detailed schedule of cost of payments as gross rental income and
Schedule M-3 (Form 1120-S), Part II, goods sold. Enter the amounts from also reports depreciation expense or
line 21d, unless the instructions for line 8, columns (a) through (d) of Form deduction. If the transaction is treated
Schedule M-3 require the amounts to be 8916-A, on Schedule M-3, Part II, as a sale, the seller/lessor reports gross
reported on another line. line 15, columns (a) through (d), as profit (sale price less cost of goods sold)
Line 15. Cost of Goods Sold applicable. Attach Form 8916-A. from the sale of assets and reports the
Report on line 15 any amounts Example 15. Corporation C is a periodic payments as payments of
deducted as part of cost of goods sold calendar year taxpayer that files and principal and interest income.
during the tax year, regardless of entirely completes Schedule M-3 for its On Part II, line 16, column (a), report
whether the amounts would otherwise current tax year. C placed in service 10 the gross profit or gross rental income
be reported elsewhere in Part II or Part depreciable fixed assets in a previous for financial accounting purposes for all
III. tax year. C's total depreciation expense sale or lease transactions that must be
for its current tax year for five of the given the opposite characterization for
Examples of amounts that must be assets is $50,000 for financial U.S. income tax purposes. On Part II,
included as cost of goods sold items are accounting purposes and $70,000 for line 16, column (d), report the gross
amounts attributable to inventory U.S. income tax purposes. C's total profit or gross rental income for federal
valuation, such as amounts attributable annual depreciation expense for its income tax purposes. Interest income
to cost-flow assumptions, additional current tax year for the other five assets amounts for such transactions must be
costs required to be capitalized is $40,000 for financial accounting

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reported on Part II, line 11, in column (a) Example 17. Corporation N is a 1. The excess of a debt instrument's
or (d), as applicable. Depreciation calendar year taxpayer that files and stated redemption price at maturity over
expense for such transactions must be entirely completes Schedule M-3 for its its issue price, as determined under
reported on Part III, line 24, in column current tax year. N was depreciating section 1273;
(a) or (d), as applicable. Use columns certain fixed assets over an erroneous 2. Amounts that are imputed interest
(b) and (c) of Part II, lines 11 and 16, recovery period and, effective for its on a deferred sales contract under
and Part III, line 24, as applicable to current tax year, N receives IRS consent section 483;
report the differences between column to change its method of accounting for
(a) and (d). the depreciable fixed assets and begins 3. Amounts treated as interest or
Example 16. Corporation M is a using the proper recovery period. The OID under the stripped bond rules under
calendar year taxpayer that files and change in method of accounting results section 1286; and
entirely completes Schedule M-3 for its in a positive section 481(a) adjustment 4. Amounts treated as OID under
current tax year. M sells and leases of $100,000 that is required to be the below-market interest rate rules
property to customers. For financial spread over 4 tax years, beginning with under section 7872.
accounting purposes, M accounts for the current tax year. In its financial
each transaction as a sale. For U.S. statements, N treats the section 481(a) Line 21a. Income Statement
income tax purposes, each of M's adjustment as a temporary difference. N Gain/Loss on Sale, Exchange,
transactions must be treated as a lease. must report on Part II, line 17, $25,000 Abandonment, Worthlessness,
In its financial statements, M treats the in columns (b) and (d) for its current tax or Other Disposition of Assets
difference in the financial accounting year and each of the subsequent 3 tax Other Than Inventory and
and the U.S. income tax treatment of years (unless N is otherwise required to
these transactions as temporary. During recognize the remainder of the 481(a) Pass-Through Entities
its current tax year, M reports in its adjustment earlier). N mustn't report the Report on line 21a, column (a), all gains
financial statements $1,000 of sales and section 481(a) adjustment on Part III, and losses on the disposition of assets
$700 of cost of goods sold regarding its line 24. except for (a) gains and losses on the
disposition of inventory, and (b) gains
current tax year lease transactions. M Line 18. Unearned/Deferred and losses allocated to the corporation
receives periodic payments of $500 in Revenue from a pass-through entity (for example,
its current tax year for these current tax
year transactions and similar Report on line 18, column (a), amounts on Schedule K-1) that are included in
transactions from prior years and treats of revenues included in Part I, line 11, the net income (loss) of the corporation
$400 as principal and $100 as interest that were deferred from a prior financial reported on Part I, line 11. Reverse the
income. For financial accounting accounting year. Report on line 18, amount reported in column (a) in
purposes, M reports gross profit of $300 column (d), amounts of revenues column (b) or (c), as applicable. The
($1,000 – $700) and interest income of recognizable for U.S. income tax corresponding gains and losses for U.S.
$100 from these transactions. For U.S. purposes in the current tax year that are income tax purposes are reported on
income tax purposes, M reports $500 of recognized for financial accounting Part II, lines 21b through 21g, as
gross rental income (the periodic purposes in a different year. Also report applicable.
payments) and (based on other facts) on line 18, column (d), any amount of Line 21b. Gross Capital Gains
$200 of depreciation deduction on the revenues reported on line 18, column
property. On its current tax year (a), that are recognizable for U.S. From Schedule D, Excluding
Schedule M-3, M must report on Part II, income tax purposes in the current tax Amounts From Pass-Through
line 11, $100 in column (a), ($100) in year. Use columns (b) and (c) of line 18, Entities
column (b), and zero in column (d). In as applicable, to report the differences Report on line 21b gross capital gains
addition, M must report on Part II, between columns (a) and (d). reported on Schedule D (Form 1120-S),
line 16, $300 of gross profit in column Line 18 mustn't be used to report Capital Gains and Losses and Built-in
(a), $200 in column (b), and $500 of income recognized from long-term Gains, or Form 8949, Sales and Other
gross rental income in column (d). contracts. Instead, use line 19. Dispositions of Capital Assets,
Lastly, M must report on Part III, line 24, excluding capital gains from
$200 in columns (b) and (d). Line 19. Income Recognition pass-through entities, which must be
From Long-Term Contracts reported on Part II, lines 7, 8, or 9, as
Line 17. Section 481(a) applicable.
Report on line 19 the amount of net
Adjustments
income or loss for financial statement Line 21c. Gross Capital Losses
With the exception of a section 481(a) purposes (or books and records, if
From Schedule D, Excluding
adjustment that is required to be applicable) or U.S. income tax purposes
reported on Part II, line 10, for for any contract accounted for under a Amounts From Pass-Through
reportable transactions, any difference long-term contract method of Entities, Abandonment Losses,
between an income or expense item accounting. and Worthless Stock Losses
attributable to an authorized (or
unauthorized) change in method of Line 20. Original Issue Discount Report on line 21c gross capital losses
accounting made for U.S. income tax and Other Imputed Interest reported on Schedule D (Form 1120-S)
or Form 8949, excluding capital losses
purposes that results in a section 481(a) Report on line 20 any amounts of from (a) pass-through entities, which
adjustment must be reported on Part II, original issue discount (OID) and other must be reported on Part II, lines 7, 8, or
line 17, regardless of whether a imputed interest. The term “original 9, as applicable; (b) abandonment
separate line for that income or expense issue discount and other imputed losses, which must be reported on Part
item exists in Part II or Part III. interest” includes, but isn't limited to: II, line 21e; and (c) worthless stock

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losses, which must be reported on Part the amount of each item and provides a deduction and the item isn't described
II, line 21f. description that states the income (loss) or included in Part II, lines 1 through 22,
name for book purposes for the amount or Part III, lines 1 through 31, report the
Line 21d. Net Gain/Loss recorded in column (a) and describes entire amount of the item in columns (a)
Reported on Form 4797, the adjustment being recorded in and (d) of line 25. If a portion of an item
Line 17, Excluding Amounts column (b) or (c). The entire description of income, loss, expense, or deduction
From Pass-Through Entities, completes the tax description for the has a difference and a portion of the
amount included in column (d) for each item doesn't have a difference, don't
Abandonment Losses, and
item separately stated on this line. report any portion of the item on line 25.
Worthless Stock Losses Instead, report the entire amount of the
The attached statement should have
Report on line 21d the net gain or loss five columns. The first column has the item (that is, both the portion with a
reported on line 17 of Form 4797, description for the next four columns. difference and the portion without a
excluding amounts from (a) The second column is column (a) difference) on the applicable line of Part
pass-through entities, which must be income (loss) per income statement, II, lines 1 through 22, or Part III, lines 1
reported on Part II, lines 7, 8, or 9, as third column is column (b) temporary through 31. See Example 10, earlier.
applicable; (b) abandonment losses, difference, the fourth column is column
which must be reported on Part II, (c) permanent difference, and the fifth Part III. Reconciliation of
line 21e; and (c) worthless stock losses, column is column (d) income (loss) per Net Income (Loss) per
which must be reported on Part II, tax return. Every item listed on the Income Statement of the
line 21f. The amount reported on attached statement for line 22 must
line 21d is the amount that would have always have columns (a) + (b) + (c) = Corporation With Total
been carried to line 17 of Form 4797 in (d). Each item with amounts in columns Income (Loss) per
the case of a corporation that isn't an S (a), (b), (c), and (d) will be totaled and Return—Expense/
corporation. included as one line on line 22.
Deduction Items
Traders in securities or If any “comprehensive income” as
TIP commodities that have made a defined by Statement of Financial Expense amounts that reduce
valid election under section Accounting Standards (SFAS) No. 130 TIP financial accounting income
475(f) to use the mark-to-market is reported on this line, describe the must be reported on Part III,
method to account for securities or item(s) in detail. Examples of sufficiently column (a), as positive amounts.
commodities, see the instructions for detailed descriptions include “Foreign Deduction amounts that reduce taxable
Part II, line 14. currency translation income must be reported on Part III,
adjustments—comprehensive income” column (d), as positive amounts.
Line 21e. Abandonment Losses and “Gains and losses on Amounts reported on Part II, line 24,
Report on line 21e any abandonment available-for-sale must be the negative of the amounts
losses, regardless of whether the loss is securities—comprehensive income.” reported on Part III, line 32.
characterized as an ordinary loss or a
capital loss. Line 23. Total Income (Loss) Lines 1 Through 6. Income Tax
Items Expense
Line 21f. Worthless Stock
Combine lines 1 through 22 and enter If the corporation doesn't distinguish
Losses the total on line 23. between current and deferred income
Report on line 21f any worthless stock tax expense in its financial statements
Line 15, Cost of goods sold,
loss, regardless of whether the loss is (or its books and records, if applicable),
TIP columns (a) and (d), are
characterized as an ordinary loss or a report income tax expense as current
negative amounts which will
capital loss. Attach a statement that income tax expense using lines 1, 3,
affect the totals entered on line 23.
separately states and adequately and 5, as applicable.
discloses each transaction that gives
rise to a worthless stock loss and the Line 24. Total Expense/ Line 7. Equity-Based
amount of each loss. Deduction Items Compensation
Report on Part II, line 24, columns (a) Report on line 7 any amounts for
Line 21g. Other Gain/Loss on through (d), as applicable, the negative equity-based compensation or
Disposition of Assets Other of the amounts reported on Part III, consideration that are reflected as
Than Inventory line 32, columns (a) through (d). For expense for financial accounting
Report on line 21g any gains or losses example, if Part III, line 32, column (a), purposes (column (a)) or deducted in
from the sale or exchange of property reflects an amount of $1 million, then the U.S. income tax return (column (d))
other than inventory that aren't reported report on Part II, line 24, column (a), ($1 other than amounts reportable
on lines 21b through 21f. million). Similarly, if Part III, line 32, elsewhere on Schedule M-3, Parts II
column (b), reflects an amount of and III. Examples of amounts reportable
Line 22. Other Income (Loss) ($50,000), then report on Part II, line 24, on line 7 include payments attributable
Items With Differences column (b), $50,000. to stock options (including incentive
Separately state and adequately Line 25. Other Items With No stock options and nonqualified stock
disclose on Part II, line 22, all items of options), employee stock purchase
Differences
income (loss) with differences that aren't plans (ESPPs), phantom stock options,
otherwise listed on Part II, lines 1 If there is no difference between the phantom stock units, stock warrants,
through 21. Attach a statement that financial accounting amount and the stock appreciation rights, and restricted
itemizes the type of income (loss) and taxable amount of an entire item of stock, regardless of whether such
income, gain, loss, expense, or

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payments are made to employees or           other indemnitors for any fines and        income (loss) amount reported in Part I, 
non-employees, or as payment for            penalties described above.                 line 11, for the current tax year and that 
property or compensation for services.                                                 isn't reportable elsewhere on 
                                            Line 10. Judgments, Damages,               Schedule M-3. For example, report 
Line 8. Meals and                           Awards, and Similar Costs                  originations and reversals of deferred 
Entertainment                               Report on line 10, column (a), the         compensation subject to section 409A 
Report on line 8, column (a), any           amount of any estimated or actual          on line 13.
amounts paid or accrued by the              judgments, damages, awards, 
corporation during the tax year for         settlements, and similar costs, however    Line 15. Charitable 
meals, beverages, and entertainment         named or classified, included in           Contribution of Intangible 
that are accounted for in financial         financial accounting income, regardless    Property
accounting income, regardless of the        of whether the amount deducted was         Report on line 15 any charitable 
classification, nomenclature, or            attributable to an estimate of future      contribution of intangible property, for 
terminology used for such amounts, and      anticipated payments or actual             example, contributions of:
regardless of how or where such             payments. Also report on line 10,          • Intellectual property, patents 
amounts are classified in the               column (a), the reversal of any            (including any amounts of additional 
corporation's financial income statement    overaccrual of any amount described in     contributions allowable by virtue of 
or the income and expense accounts          this paragraph.                            income earned by donees subsequent 
maintained in the corporation's books                                                  to the year of donation), copyrights, 
                                            Report on line 10, column (d), any 
and records. Report only amounts not                                                   trademarks;
                                            such amounts as are described in the 
otherwise reportable elsewhere on                                                      • Securities (including stocks and their 
                                            preceding paragraph that are includible 
Schedule M-3, Parts II and III (for                                                    derivatives, stock options, and bonds);
                                            in taxable income, regardless of the 
example, Part II, line 15).                                                            • Conservation easements (including 
                                            financial accounting period in which 
Line 9. Fines and Penalties                 such amounts were or are included in       scenic easements or air rights);
Report on line 9 any fines or similar       financial accounting net income.           • Railroad rights of way;
penalties paid to a government or other     Complete columns (b) and (c) as            • Mineral rights; and
authority for the violation of any law for  appropriate.                               • Other intangible property.
which fines or penalties are assessed.      Don't report on this Part III, line 10,    Line 16. Current Year 
All fines and penalties expensed in         amounts required to be reported in         Acquisition or Reorganization 
financial accounting income (paid or        accordance with instructions for Part III, Investment Banking Fees
accrued) must be included on this line 9,   line 9.                                    Report on line 16 any investment 
column (a), regardless of the 
government or other authority that          Don't report on this Part III, line 10,    banking fees paid or incurred in 
imposed the fines or penalties,             amounts recovered from insurers or any     connection with a taxable or tax-free 
regardless of whether the fines and         other indemnitors for any judgments,       acquisition of property (for example, 
penalties are civil or criminal, regardless damages, awards, or similar costs          stock or assets) or a tax-free 
of the classification, nomenclature, or     described above.                           reorganization. Report on this line any 
                                                                                       investment banking fees incurred at any 
terminology used for the fines or           Line 11. Pension and                       stage of the acquisition or 
penalties by the imposing authority in its 
actions or documents, and regardless of     Profit-Sharing                             reorganization process including, for 
how or where the fines or penalties are     Report on line 11 any amounts              example, fees paid or incurred to 
classified in the corporation's financial   attributable to the corporation's pension  evaluate whether to investigate an 
income statement or the income and          plans, profit-sharing plans, and any       acquisition, fees to conduct an actual 
expense accounts maintained in the          other retirement plans.                    investigation, and fees to consummate 
                                                                                       the acquisition. Also include on this 
corporation's books and records. Also       Line 12. Other Post-Retirement             line 16 investment banking fees incurred 
report on line 9, column (a), the reversal 
of any overaccrual of any amount            Benefits                                   in connection with the liquidation of a 
described in this paragraph. See section    Report on line 12 any amounts              subsidiary, a spin-off of a subsidiary, or 
162(f) for additional guidance.             attributable to other post-retirement      an initial public stock offering.
                                            benefits not otherwise includible on Part  Line 17. Current Year 
Report on line 9, column (d), any           III, line 11 (for example, retiree health 
such amounts as described in the            and life insurance coverage, dental        Acquisition or Reorganization 
preceding paragraph that are includible     coverage, etc.).                           Legal and Accounting Fees
in taxable income, regardless of the                                                   Report on line 17 any legal and 
financial accounting period in which        Line 13. Deferred                          accounting fees paid or incurred in 
such amounts were or are included in        Compensation                               connection with a taxable or tax-free 
financial accounting net income.            Report on line 13, column (a), any         acquisition of property (for example, 
Complete columns (b) and (c) as             compensation expense included in the       stock or assets) or tax-free 
appropriate.                                net income (loss) amount reported in       reorganization. Report on this line any 
Don't report on this Part III, line 9,      Part I, line 11, that isn't deductible for legal and accounting fees incurred at 
amounts required to be reported in          U.S. income tax purposes in the current    any stage of the acquisition or 
accordance with instructions for Part III,  tax year and that wasn't reported          reorganization process including, for 
line 10.                                    elsewhere on Schedule M-3, column          example, fees paid or incurred to 
                                            (a). Report on line 13, column (d), any    evaluate whether to investigate an 
Don't report on this Part III, line 9,      compensation deductible in the current     acquisition, fees to conduct an actual 
amounts recovered from insurers or any      tax year that wasn't included in the net 

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investigation, and fees to consummate gas that isn't required to be reported life insurance policy if the corporation is
the acquisition. Also include on this line elsewhere on Schedule M-3 (for directly or indirectly a beneficiary under
legal and accounting fees incurred in example, on Part II, line 7, 8, 9, or 15). the policy or if the policy has a cash
connection with the liquidation of a value. Report in column (d) the amount
subsidiary, a spin-off of a subsidiary, or Line 24. Depreciation of the premiums that are deductible for
an initial public stock offering. Report on line 24 any depreciation federal income tax purposes.
expense that isn't required to be
Line 18. Current Year reported elsewhere on Schedule M-3 Line 28. Purchase Versus
Acquisition/Reorganization (for example, on Part II, line 7, 8, 9, or Lease (for Purchasers and/or
Other Costs 15). Lessees)
Report on line 18 any other fees paid or Line 25. Bad Debt Expense Also see the instructions for
incurred in connection with a taxable or Report on line 25, column (a), any TIP sellers and/or lessors in the
tax-free acquisition of property (for amounts attributable to an allowance for instructions for Part II, line 16.
example, stock or assets) or a tax-free uncollectible accounts receivable or
Asset transfer transactions with periodic
reorganization not otherwise reportable actual write-offs of accounts receivable
payments characterized for financial
on Schedule M-3 (for example, Part III, included on Part I, line 11. Report in
accounting purposes as either a
line 16 or 17). Report on this line any column (d) the amount of bad debt
purchase or a lease may, under some
fees paid or incurred at any stage of the expense deductible for federal income
circumstances, be characterized as the
acquisition or reorganization process tax purposes under section 166.
including, for example, fees paid or opposite for tax purposes.
incurred to evaluate whether to Line 26. Interest Expense
If a transaction is treated as a lease,
investigate an acquisition, fees to Attach Form 8916-A. Complete Part III the purchaser/lessee reports the
conduct an actual investigation, and and enter the amounts shown on line 5, periodic payments as gross rental
fees to consummate the acquisition. columns (a) through (d), on expense. If the transaction is treated as
Also include on this line other Schedule M-3, line 27, columns (a) a purchase, the purchaser/lessee
acquisition/reorganization costs through (d), as applicable. reports the periodic payments as
incurred in connection with the
liquidation of a subsidiary, a spin-off of a Any corporation that files Form payments of principal and interest and
subsidiary, or an initial public stock TIP 1120-S that (a) is required to file also reports depreciation expense or
offering. a Schedule M-3 and has less deduction regarding the purchased
than $50 million in total assets at the asset.
Line 19. Amortization/ end of the tax year or (b) isn't required Report in column (a) gross rent
Impairment of Goodwill to file a Schedule M-3 and voluntarily expense for a transaction treated as a
Report on line 19 amortization of files a Schedule M-3, isn't required to lease for financial accounting purposes
goodwill or amounts attributable to the file Form 8916-A but may voluntarily do but as a sale for U.S. income tax
impairment of goodwill. so. purposes. Report in column (d), gross
rental deductions for a transaction
Line 20. Amortization of Report on Part III, line 26, column (a), treated as a lease for U.S. income tax
Acquisition, Reorganization, the total amount of interest expense purposes but as a purchase for financial
and Start-Up Costs included on Part I, line 11, and report on accounting purposes. Report interest
Part III, line 26, column (d), the total
Report on line 20 amortization of expense for such transactions on Part
amount of interest deduction included
acquisition, reorganization, and start-up III, line 26, in column (a) or (d), as
on Form 1120-S, Schedule K, line 18,
costs. For purposes of columns (b), (c), applicable. Report depreciation
that isn't required to be reported
and (d), include amounts amortizable expense or deductions for such
elsewhere on Schedule M-3. In columns
under section 167, 195, or 248. transactions on Part III, line 24, in
(b) or (c), as applicable, include any column (a) or (d), as applicable. Use
Line 21. Other Amortization or adjustments for any amounts treated for columns (b) and (c) of Part III, lines 24,
Impairment Write-Offs U.S. income tax purposes as interest 26, and 28, as applicable, to report the
deduction that are treated as some differences between column (a) and (d)
Report on line 21 any amortization or other form of expense for financial for such recharacterized transactions.
impairment write-offs not otherwise accounting purposes, or vice versa. For
includible on Schedule M-3. example, adjustments to interest Example 18. U.S. Corporation X is a
Line 22. expense/deduction resulting from calendar year taxpayer that files and
When using this line to figure amounts adjustments made in accordance with entirely completes Schedule M-3 for its
on other tax forms or worksheets, this the instructions for Part III, line 28, current tax year. X acquired property in
line should be considered to be zero. should be made in columns (b) and (c), a transaction that, for financial
as applicable, of this line 26. accounting purposes, X treats as a
Line 23a. Depletion—Oil & Gas lease. Because of its terms, the
Don't report on Form 8916-A and on transaction is treated for U.S. income
Report on line 23a, column (a), any oil line 26 amounts reported in accordance tax purposes as a purchase and X must
and gas depletion included on Part I, with the instructions for Part II, lines 7, 8, treat the periodic payments it makes
line 11. 9, and 10. partially as payment of principal and
partially as payment of interest. In its
Line 23b. Depletion—Other Line 27. Corporate Owned Life financial statements, X treats the
than Oil & Gas Insurance Premiums difference between the financial
Report on line 23b any depletion Report on line 27 all amounts of accounting and U.S. income tax
expense/deduction other than oil and insurance premiums attributable to any treatment of this transaction as a

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temporary difference. During its current which they are paid or incurred, or they column (d). X must also report $6,000 in
tax year, X reports in its financial may be deferred and amortized. column (a), ($4,000) in column (b), and
statements $1,000 of gross rental Example 19. Corporation X is a $2,000 in column (d) on Part III, line 24.
expense that, for U.S. income tax calendar year taxpayer that files and Example 22. Corporation X is a
purposes, is recharacterized as a $700 entirely completes Schedule M-3 for its calendar year taxpayer that files and
payment of principal and a $300 current tax year. During its current tax entirely completes Schedule M-3 for its
payment of interest, accompanied by a year, X incurred $100,000 of research current tax year. During its current tax
depreciation deduction of $1,200 and development costs that X year, X incurred $10,000 of research
(based on other facts). On its current tax recognized as an expense in its and development costs related to social
year Schedule M-3, X must report the financial statements. Also, X incurred sciences that it recognized as an
following on Part III, line 28: column (a), $20,000 in attorney fees in obtaining a expense in its financial statements. X
$1,000, its financial accounting gross patent application that X capitalized and adopted the current expense method for
rental expense; column (b), ($1,000); amortized in its financial statements. X research and experimental
and column (d), zero. On Part III, line 26, recognized a $2,000 amortization expenditures for U.S. income tax
X reports zero in column (a) and $300 in deduction. In compliance with its purposes. Because such costs aren't
columns (b) and (d) for the interest adopted method of accounting under allowable costs under section 174, X
deduction. On Part III, line 24, X reports section 174, X deducts research and must report $10,000 in column (a),
zero in column (a) and $1,200 in experimental expenditures for U.S. permanent difference ($10,000) in
columns (b) and (d) for the depreciation income tax purposes. Accordingly, X column (c), and $0 in column (d). If such
deduction. must report $100,000 in column (a), costs are otherwise deductible for U.S.
Line 29. Research and $20,000 in column (b), and $120,000 in income tax purposes, X must report this
Development Costs column (d). X must also report $2,000 in item of expense on Part III, line 31.
column (a), ($2,000) in column (b), and Example 23. Corporation X is a
Report in column (a) the amount of $0 in column (d) on Part III, line 21. calendar year taxpayer that files and
expenses included in net income
reported on Part I, line 11, that are Example 20. Assume the same entirely completes Schedule M-3 for its
related to research and development facts as Example 19 except Corporation current tax year. During its current tax
expense. Report in column (d) the X elected to capitalize and amortize its year, X paid $75,000 to acquire or
amount of deductions included in Form research and expenditures over 60 in-license intangible assets under a
1120-S, line 21, and/or separately months for all its research programs for collaborative arrangement with another
reported on Form 1120-S, Schedule K, U.S. tax purposes. X first realized company that X recognized as a
that are recognized and reported as benefits from such expenditures on research and development expense in
Section 174 research and experimental August 1. Accordingly, X must report its financial statements. X adopted the
expenditures consistent with the $100,000 in column (a), a temporary current expense method for research
corporation’s adopted method of difference of ($90,000) ($20,000 less and experimental expenditures for U.S.
accounting for such expenditures. In ($120,000/60 months X 55 months)) in income tax purposes. Because
column (c), as applicable, include any column (b), and $10,000 in column (d). payments made to acquire rights to a
adjustments for any amounts treated for Example 21. Corporation X is a product or technology are excluded
U.S. income tax purposes as research calendar year taxpayer that files and costs from the definition of research and
or experimental expenditures that are entirely completes Schedule M-3 for its experimental expenditures, X must
treated as some other form of expense current tax year. X adopted the current report $75,000 in column (a), ($75,000)
for financial accounting purposes, or expense method for research and in column (c), and $0 in column (d). X
vice versa. Report any difference in experimental expenditures for U.S. must report any amortization otherwise
timing recognition in column (b). For income tax purposes. During it current allowable related to the payments on
example, if the taxpayer's financial tax year, X incurred $50,000 of research Part III, line 21.
accounting method doesn't specify and development costs that X Line 30. Section 118 Exclusion
otherwise, column (b) adjustments recognized as an expense in its
Report on line 30 any inducements
include adjustments for timing financial statements. Also, X undertook
received in the current year and treated
differences between financial and tax to develop a new machine for its
as contributions to the capital of a
accounting for: (1) deferral and business. X expended $30,000 on the
corporation by a non-shareholder. The
amortization of research expenditures, project of which $10,000 represents
following non-shareholder contributions
(2) reduction of section 174 actual costs of material, labor, and
to capital are not eligible for exclusion
expenditures under section 280C or component cost to construct the
under section 118.
section 482, (3) costs attributable to machine, and $20,000 represents
obtaining a patent, (4) research in social research costs not attributable to the • Any contribution in aid of construction
or any other contribution as a customer
sciences, and (5) cost elements for machine itself. X capitalized all costs of
or potential customer.
property of a character subject to $30,000 related to the machine and
depreciation. recognized $6,000 of depreciation • Any contribution by any civic group.
expense in its financial statements. X’s • Any contribution by any governmental
entity, except any contribution made
Section 174 provides two methods depreciation expense on the $10,000 of
after December 22, 2017, and made
for the treatment of research and costs related to the machine itself was
pursuant to a master development plan
experimental expenditures paid or $2,000 for U.S. income tax purposes.
that was approved prior to December
incurred by a taxpayer in connection Accordingly, X must report $50,000 in
22, 2017, by a governmental entity.
with the taxpayer’s trade or business. column (a), $20,000 (research costs
These expenditures may be treated as which aren't attributable to the machine
expenses not chargeable to a capital itself) in column (b), and $70,000 in
account and deducted in the year in

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Report in column (a) any income lease cancellation costs, loss on sale of deductible in the current tax year for
amount as a negative number and any equipment, etc., a supporting statement U.S. income tax purposes. Examples of
expense amount as a positive number. that lists those categories of expenses reserves that are allowed for book
Corporations must identify on an and their details will satisfy the purposes, but not for tax purposes,
accompanying statement referencing requirement to separately state and include warranty reserves, restructuring
line 36 the fair market value of land or adequately disclose. In order to reserves, reserves for discontinued
other property (including cash) provided separately state and adequately operations, and reserves for
to the corporation by any disclose the employee termination acquisitions and dispositions. Only
non-shareholder, including a costs, it isn't required that an anticipated report on line 31 items that aren't
governmental unit as an inducement, or termination cost amount be listed for required to be reported elsewhere on
for any other purpose. each employee, or that each asset (or Schedule M-3, Parts II and III.
category of asset) be listed along with Example 24. Corporation Q is a
On the accompanying statement, the anticipated loss on disposition. calendar year taxpayer that files and
also identify any inducements that
entirely completes Schedule M-3 for its
include refundable or transferable tax The attached statement should have
current tax year. On July 1 of each year,
credits, including transferable credits five columns. The first column has the
Q has a fixed liability for its annual
that were sold. description for the next four columns.
insurance premiums on its home office
The statement must separately state, The second column is column (a)
building that provides a 12-month
adequately disclose, and identify all of expense per income statement, the third
the dollar amounts summarized by this column is column (b) temporary coverage period beginning July 1
through June 30. In addition, Q
line. An accompanying statement is difference, the fourth column is column
historically prepays 12 months of
required even if there are no dollar (c) permanent difference, and the fifth
advertising expense on July 1. On July
amounts reported on line 30. column is column (d) deduction per tax
return. Every item listed on the attached 1 of its current tax year, Q prepays its
insurance premium of $500,000 and
Line 31. Other Expense/ statement for line 31 must always have
advertising expenses of $800,000. For
Deduction Items With columns (a) + (b) + (c) = (d). Each item
financial accounting purposes, Q
with amounts in columns (a), (b), (c),
Differences capitalizes and amortizes the prepaid
and (d) will be totaled and included as
insurance and advertising over 12
Separately state and adequately one line on line 31.
disclose on Part III, line 31, all items of months. For U.S. income tax purposes,
expense/deduction that aren't otherwise Comprehensive income. If any Q deducts the insurance premium when
listed on Part III, lines 1 through 30. “comprehensive income” as defined by paid and amortizes the advertising over
SFAS No. 130 is reported on this line, the 12-month period. In its financial
Attach a statement that describes describe the item(s) in detail as, for statements, Q treats the differences
and itemizes the type of expense/ example, “Foreign currency translation attributable to the financial statement
deduction and the amount of each item, adjustments—comprehensive income” treatment and U.S. income tax
and provides a description that states and “Gains and losses on treatment of the prepaid insurance and
the expense/deduction name for book available-for-sale advertising as temporary differences.
purposes for the amount recorded in securities—comprehensive income.” Q also has a legal expense reserve
column (a) and describes the
adjustment being recorded in column Reserves and contingent liabilities. where $300,000 was expensed for
(b) or (c). The entire description Report on line 31 amounts related to the financial accounting purposes and a
completes the tax description for the change in each reserve or contingent ($100,000) temporary difference was
amount included in column (d) for each liability that isn't required to be reported calculated to arrive at the income tax
item separately stated on this line. elsewhere on Schedule M-3. For deduction of $200,000. The statement
example: (1) amounts relating to attached to Q's return for Part III, line 31,
The statement of details attached to changes in reserves for litigation must must be separately stated and
the Schedule M-3 for line 31 must be reported on Part III, line 10; and (2) adequately disclosed as shown below.
separately state and adequately amounts relating to changes in reserves
disclose the nature and amount of the for uncollectible accounts receivable Line 32. Total Expense/
expense related to each reserve and/or must be reported on Part III, line 25. See Deduction Items
contingent liability. The appropriate level Example 8 and Example 9, earlier; and Report on Part II, line 24, columns (a)
of disclosure depends upon each Example 24, later. though (d), as applicable, the negative
taxpayer’s operational activity and the
nature of its accounting records. For Report on line 31, the amortization of of the amounts reported on Part III,
example, if a corporation’s net income various items of prepaid expense, such line 32, columns (a) through (d), as
amount reported in the income as prepaid subscriptions and license applicable. Report positive amounts as
statement includes anticipated fees, prepaid insurance, etc. negative and negative amounts as
expenses for a discontinued operation Report on line 31, column (a), positive. For example, if Part III, line 32,
as a single amount, and its general expenses included in net income column (a), reflects an amount of $1
ledger or other books, records, and reported on Part I, line 11, that are million, then report on Part II, line 24,
work papers provide details for the related to reserves and contingent column (a), ($1 million). Similarly, if Part
anticipated expenses under more liabilities. Report on line 31, column (d), III, line 32, column (b), reflects an
explanatory and defined categories, amounts related to liabilities for reserves amount of ($50,000), then report on Part
such as employee termination costs, and contingent liabilities that are II, line 24, column (b), $50,000.

Instructions for Schedule M-3 (Form 1120-S) -19-

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Line 31—Example 24
Statement Concerning Other Expense/Deduction Items With Differences

                          Column (a) Expense   Column (b) Temporary   Column (c)           Column (d) Deduction 
Description               per Income Statement Difference             Permanent Difference per Tax Return
Prepaid insurance premium 
expensed not capitalized  $250,000             $250,000               -0-                  $500,000
Legal expense reserve     $300,000             ($100,000)             -0-                  $200,000
Total line 31             $550,000             $150,000               -0-                  $700,000

                                               -20-                   Instructions for Schedule M-3 (Form 1120-S)

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